• Banking lobby spent its way around regulation Monday, September 21, 2009

    By Jill Replogle

    Civil Justice Research & Education Project

    SACRAMENTO–A senior executive for mortgage lending giant, New Century Financial Corp., calmly assured California legislators that risks associated with subprime loans were entirely manageable. Lawmakers should be exceedingly careful about requiring any changes, or else Californians would be frozen out of the housing market, he warned.

    The date was Jan. 31, 2007.

    The Senate banking committee had convened in a first floor hearing room in the Capitol hoping to sort out the reasons behind nagging reports from their districts about the rise in foreclosures.

    “These products perform well in the marketplace, and are adequately managed by the primary and secondary mortgage markets,” Marc Lowenthal, senior vice president of New Century, told committee members.

    In his testimony, Lowenthal extolled non-traditional mortgage products, saying they had made home ownership affordable and helped borrowers improve their credit ratings. Importantly, he said, this new style of lending was allowing working Californians to “build financial safety nets” for themselves.

    The New Century executive warned that expanding on federal guidelines to limit a widely-used class of subprime loans in California would depress the housing market, “cutting off home ownership to deserving families and significantly affecting the nation’s economic health.”

    Within one month, New Century’s stock price had plummeted.

    On April 2, 2007, it filed for bankruptcy.

    New Century once had 7,200 employees and made more than $75 billion in loans in a three-year period, making it the third largest subprime lender in the nation. The Irvine-based firm had employed 3,000 mortgage professionals in California at the time of the hearing. More than 30% of its loans went to Californians.

    Now, New Century stands as a symbol of mismanagement and avarice in an industry that accounted for 20% of the nation’s home loans in 2006, the year before the real estate bubble burst and set off the biggest blow to the nation’s economic health since the Great Depression.

    California’s golden rule: those with the gold rule

    The Obama Administration, Congress and federal regulators are struggling to mop up the mess and prevent further economic decline. To be sure, the failings of Washington’s lawmakers and regulators opened the way for the debacle. But California state authorities share a measure of blame. Many decisions made and not made in this state’s Capitol helped worsen the crisis.

    “It was the state-regulated entities that caused most of the problem,” said Paul Leonard, California director of the Center for Responsible Lending, a group that has long advocated for an overhaul of lending practices. At the height of the industry’s boom, more than 70% of subprime loans were made through brokers, most of who are overseen by state regulators.

    Nine of the top ten subprime lenders nationally were based in California, though the impact of their business extended far beyond this state’s borders. The loans they sold were repackaged, collateralized, bought by investors, and now are all-too-well known as toxic assets, requiring $700 billion in taxpayer bail-outs.

    There is no better barometer of the power of state government than the amount that moneyed interests spend to try to influence it.

    Banks and other corporations most heavily involved in the subprime mortgage industry spent $59 million in campaign contributions and lobbying in Sacramento during this decade, fighting to keep state regulators off their backs and blocking or weakening proposals that sought to curb risky lending, according to an examination of records and interviews with some of the key players.

    Bail-out or not, lobbying never stops

    The lobbying continues.

    Recipients of federal bail-outs and loan guarantees including Bank of America, American International Group and others spent more than $2.6 million on lobbying in the first three quarters of the year in California, and handed out $975,000 in campaign donations. Spending on lobbying dipped somewhat from $3.2 million during the first three quarters of 2008, and $2.8 million in 2007. But some political players spent more.

    One particularly generous campaign donor was General Electric, the New York-based conglomerate that had a subprime lending subsidiary earlier in the decade. General Electric benefited from a $74 billion debt guarantee granted by Uncle Sam late last year.

    In the first six months of this year, GE donated $785,000 to California campaigns, nearly matching the sums the corporation had spent on California state campaigns in the first eight years of the decade combined.

    general electric year by year

    The bulk of its campaign money–$605,000– went to Gov. Arnold Schwarzenegger’s campaign committees. Another $165,000 went to the Chamber of Commerce and California Republican Party, which helped fund Schwarzenegger-backed ballot measures earlier this year.

    GE spent an additional $397,000 to lobby California state officials in the first three quarters of the year. That is more than GE spent on lobbying here than it did for the entire year of 2008.

    In Sacramento, GE focused much of its lobby effort on blocking state tax hikes and win new breaks, including one that in time could provide GE’s entertainment subsidiary, NBC-Universal, with film industry tax credits created by Schwarzenegger and legislators earlier this year. GE did not respond to requests for comment. The Schwarzenegger administration defends its stands on taxes, and says campaign money has nothing to do with decisions.

    “The economic stimulus measures the Governor pushed for in the budget are saving jobs in a broad range of California industries,” Schwarzenegger spokesman Aaron McLear said. “The Governor always makes decisions based on what’s best for California.”

    California’s crisis is not over

    California has been at the epicenter of the mortgage crisis that has shaken the nation’s economy. One in 144 homes in California are in foreclosure, ranking this state third worst after Nevada and Florida among all 50 states. It may get worse. By the end of July, nearly one in 10 California homes had been in default. Industry experts predicted that roughly 60% of those homes could end up in foreclosure.

    “California is obviously ground zero,” said John Dunbar, lead author of a report on the subprime industry by the Center for Public Integrity, a Washington D.C.-based watchdog group that has reported on the subprime industry. “I don’t think a lot of this would have happened if it weren’t for whatever’s in the water there.”

    A look back at legislative history shows how the mortgage and banking industries helped beat back efforts to curb their highly lucrative, and increasingly popular, game of risky lending.

    The subprime industry began to blossom in the mid-1990s, spurred on by a strong real estate market, low interest rates and federal encouragement to spread the “American Dream” of home-ownership to many who had traditionally been unable to get a loan. Subprime loans were originally designed for people with less-than-stellar credit ratings or a source of income that was difficult to document, such as self-employment.

    Wall Street banks discovered a gold mine by buying up the loans, packaging them and selling them off as securities. Bankers spurred subprime lenders, many of them owned or funded by the big banks, to slacken underwriting standards and offer the loans to ever more borrowers.

    Subprime lending increased 10-fold during the second half of the 1990s. By 2006, one in every five mortgage loans originated was subprime and one in five was originated in California. Some consumer protection groups, like the Center for Responsible Lending, warned about the boom in a largely unregulated sector, and sought to convince legislators at the state and national level to rein in certain practices before it was too late.

    Though some California legislators paid attention, their efforts to curb risky lending were largely muffled by industry lobbying.

    “The industry basically had a stranglehold on the legislature,” said Norma Garcia, a senior attorney for Consumers Union who has lobbied for lending reform since the 1990s.

    Dustin Hobbs, communications director for the California Mortgage Bankers Association, scoffed at the notion that proposed legislation in recent years could have prevented the mortgage crisis.

    Fraud was rampant, Hobbs said, and the culprits were various, including consumers who took out loans they couldn’t afford, brokers pushing bad products on buyers, and consumer groups pushing lenders and Washington to make more loans available to more people.

    “Everybody should have done something differently,” said Hobbs, who represents Bank of America and Wells Fargo as well as small and mid-sized mortgage lenders.

    Subprime players spent strategically

    Since the start of the decade, the nation’s largest subprime mortgage lenders delivered no less than $21.5 million in campaign donations to California state politicians and causes, and spent another $37 million to lobby state regulators, the governor’s office, and legislators, a review of Secretary of State disclosures show.

    The top five recipients of those campaign donations are telling. The California Republican Party and the GOP’s county committees received the most, at $3.4 million. The GOP was the No. 1 recipient even though California in recent years has leaned heavily Democratic. One reason to give to the GOP is that Schwarzenegger is a Republican. Schwarzenegger has made heavy use of the costly initiative process, and the Republican Party has helped pay for those measures.

    The second largest recipient was California’s governor himself and his ballot measure committees, at $2.9 million.

    Schwarzenegger is by far the largest recipient of the subprime industry’s largesse of any state officeholder or candidate in the nation. That conclusion is based on data collected by California Secretary of State and other state elections officials, and compiled by ProtectConsumerJustice.org and the National Institute for Money in State Politics, a nonpartisan organization based in Helena, Mont.

    The California Democratic Party was the third largest recipient, at $2.05 million.

    The fourth biggest recipient was Sacramento’s largest business lobby group—the California Chamber of Commerce, at $1.26 million. Fifth was Proposition 64, a 2004 initiative approved by voters that was touted by business and tort “reform” advocates, and intended to restrict consumers’ right to bring class action lawsuits. Lenders, many of which became targets of class action lawsuits, gave $675,000 to the initiative, and another $253,000 to Proposition 64’s main proponent, Civil Justice Association of California, during this decade.

    Just as telling are the bills intended to restrict lending practices that the industry fought to water down or kill as the subprime loan crisis loomed.

    A tough bill became softer

    In 2001, then Assemblywoman Carole Migden (D-San Francisco) introduced the Covered Loan Law, AB 489. The measure sought to define “predatory lending practices” in the subprime market and ban brokers from offering predatory loans to low-income Californians.

    At least, that’s what the bill proposed to do before going through an eight-month process of gutting, amendments and revisions. Garcia of Consumers Union said the final product, while a start, did little to restrict risky lending.

    At the time, dozens of states and cities across the country were debating ways to curb predatory lending practices. Consumer advocacy groups said these practices were artificially inflating the cost of subprime home loans and increasing the risk of foreclosure. These practices included steering, charging hefty pre-payment penalties and encouraging loan refinance despite little or no benefit to the borrower, all of which are still legal for most loans in California.

    Representatives of the booming mortgage industry reacted swiftly. Major subprime lenders met earlier that year to map out strategies for combating the wave of predatory lending laws, including dispatching lobbyists across the country, according to an April 4, 2001 article in the New York Times.

    At the national level, mortgage industry campaign contributions to federal campaigns hit a 10-year high during the 2002 election cycle, according to the nonpartisan Center for Responsive Politics in Washington. Spending on federal campaigns by the industry totaled $12.6 million in 2001 and 2002.

    Back in California, Household International, then one of the nation’s biggest subprime lenders, lobbied hard against Migden’s bill.

    In a Sept. 10, 2001 letter to state assembly members, Household wrote that the bill would result in higher credit costs to customers and likely reduce the amount of credit available to those “with the greatest need.”

    The company insisted in its letter that existing laws were “comprehensive and certainly prohibit fraudulent and deceptive practices” in the mortgage industry.

    As Migden’s bill progressed between 2000 and 2002, Household International spent $663,000 to lobby California state officials, and $270,000 on campaign donations.

    In 2002, Household International paid $484 million to settle a nationwide predatory lending suit, the largest of its kind in the nation’s history. The firm was bought by HSBC in 2003.

    The California Mortgage Association also lobbied against Migden’s bill, warning the bill would “create redlining through legislative action” in a letter to Assembly members. “Poor people will not get loans,” said the letter, contained in the archived bill file. “People will lose their homes.”

    Gov. Gray Davis signed Migden’s bill in October 2001. It did provide protection for borrowers of certain high-risk loans against excessive points and fees. The law also restricted prepayment penalties and the practice of “steering” borrowers into higher-cost loans.

    “It was a fledgling but strong beginning step,” said Migden. “I’m proud that we had the foresight to pierce a powerful industry.”

    Nevertheless, most subprime loans weren’t covered by the law, and lenders and brokers simply stopped making loans that would have been covered. Despite dire warnings from the industry, subprime loans continued to flow.

    Another tough bill never had a chance

    Four years after Davis signed Migden’s bill, then-State Senator Jackie Speier (D-Hillsborough) introduced a bill, SB 790 of 2005, which would have expanded the definition of covered loans and established additional protections for borrowers.

    Consumer groups supported the bill. Lobbyists for the mortgage industry said it would chase lenders out of the subprime market.

    Industry lobbying was so effective that the bill “went down in flames,” as Garcia put it, in the very committee Speier chaired, Senate Banking, Finance and Insurance.

    Speier, now a member of Congress, got only one other vote on the 11-member committee. Five Democrats abstained.

    “There is this unwritten rule that the chair always gets her bill out of committee,” said Speier.

    In the eight years she chaired the committee, “this is the only bill I couldn’t get out,” she said.

    Investors and brokers making big bucks in the booming real estate market weren’t risking any intrusion on their territory, especially by state regulators.

    “That was the wild, wild West,” Speier said. “Even the modest protections were too much.”

    Speier pushed her bill at a time when the subprime industry was throwing around its weight—in the form of campaign donations and lobbying expenditures—like never before. In 2004 and 2005, the subprime industry campaign spending on California campaigns hit its height—more than $9 million.

    Subprime donations in California by year

    Subprime had a formidable lobby corps

    Opponents of Speier’s bill included the California Mortgage Bankers Association, California Mortgage Association, California Bankers Association and individual mortgage firms.

    One of these firms was Option One Mortgage, whose former CEO and other executives formed New Century.

    They also included Calabasas-based Countrywide Financial Corp., then the largest subprime lender, and since absorbed by Bank of America.

    Countrywide Financial Corp. spent $1.76 million on lobbying during the decade and shelled out another $2.1 million in campaign donations.

    Ameriquest Mortgage Co., the nation’s second largest subprime lender, was the biggest political player.

    From its base in Orange County, Ameriquest became responsible for $80.6 billion in loans, according to the study by the Center for Public Integrity.

    “Ameriquest was a very generous donor,” said Speier, “both to Democrats and to Republicans.”

    Ameriquest and its principals doled out $11.5 million in campaign donations to California politicians and causes between 2000 and its collapse in 2006.

    In California, Ameriquest gave $3.2 million to the California Republican Party between 2000 and 2006, and $1.7 million to Schwarzenegger and his ballot measure committees, plus $1.3 million to the Democratic Party and various Democratic committees.

    Ameriquest was a heavy donor to business lobby groups, too, giving $900,000 to California Chamber of Commerce campaign committees, another $164,000 a political action controlled by the Civil Justice Assn. of California, plus $105,000 to Proposition 64, the 2004 initiative to curb consumer lawsuits.

    Ameriquest had an interest in curbing litigation. It faced a barrage of suits brought by state attorneys general and private attorneys over its predatory lending practices. It ultimately settled those cases for $325 million in 2006.

    Ameriquest gained notoriety for its political activities. News accounts detailed how the company feted aides to Schwarzenegger, state legislators of both parties, and other top officials. They flew lawmakers and their spouses to Hawaii and Aspen, and provided hard-to-get tickets to Super Bowls and Rolling Stones concerts in 2005 in Anaheim and San Francisco. On one trip to Honolulu in February 2005, Ameriquest spent $4,129 on a meal for Democratic legislators, and another $170 on cookies.

    In addition to its campaign donations, Ameriquest spent $1.8 million to lobby California state officials. That was more than three times the $540,000 Ameriquest spent on lobbying federal officials and lawmakers in Washington, D.C., during this decade, federal lobby reports show.

    Its California campaign donations roughly equaled the $12 million that Ameriquest and its founder, the late billionaire Roland Arnall and his wife, Dawn Arnall, spent on federal campaigns.

    Much of Arnall’s money was spent to help President Bush’s reelection in 2004. Arnall also spent $1 million to help pay Bush at his second inaugural. Bush, in turn, rewarded Arnall by appointing him ambassador to the Netherlands. Arnall died in March 2008.

    Like the feds, state regulators fell short

    One reason Ameriquest, New Century and many other subprime lenders focused their political efforts in California was that state regulated them.  Ameriquest was not a bank—it accepted no deposits—so federal regulators had no direct oversight role. But of course Ameriquest could not have flourished without Wall Street. Banks bought Ameriquest’s loans and bundled them into what have become all-too-well known as toxic assets.

    By 2006, federal regulators had begun to smell the dangers of the lending frenzy and took some action to curb what they considered risky lending among banking entities under their control.

    In September of that year, the federal government issued voluntary “guidance” that states could consider imposing on purveyors of nontraditional mortgage products, including “interest-only” mortgages and “payment option” adjustable-rate mortgages.

    But the guidance only applied to federally-chartered banking institutions, not state-chartered lending firms, like Countrywide, Ameriquest or New Century.

    Many states quickly applied the federal guidance to state-chartered firms. Other states enacted even stricter guidelines or laws.

    On Jan. 31, 2007, the Senate Banking, Finance and Insurance Committee convened to discuss how California should react to the federal guidance.

    That was the hearing in which Lowenthal, speaking for New Century, assured legislators that all was well. The problem was not risky loans, but rather California’s high real estate prices, Lowenthal said.

    “We caution California policymakers to take a careful and deliberate approach to the guidance as they determine which elements make sense for California,” Lowenthal told the committee. “Unlike other states, the guidance if adopted too strictly in California, could further exacerbate the state’s already serious affordability crisis.”

    Leonard, of Center for Responsible Lending, offered a counterpoint at the hearing.

    He predicted one in five subprime loans originated in the state in 2006 would end in foreclosure.

    Then Sen. Lou Correa (D-Santa Ana), now an assembly member, seemed skeptical. He mused that it would “be interesting to see if the doomsday projections play out.”

    That prediction, as we now know, turned out to be and then some.

    (Replogle is a student at UC Berkeley’s Graduate School of Journalism and was a summer intern for Civil Justice Research & Education Project; )

    Next: What the banking industry sought and got in 2009

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