The Watchdog That Didn’t Bark: The Financial Crisis and the Disappearance of Investigative Reporting

In 1991, Peter S. Canellos, an urban-affairs reporter for the Boston Globe, started to hear from housing activists about a strange new phenomenon emerging on his beat: swarms of home-improvement salesman were turning up on the front porches of elderly homeowners in Boston’s inner city, selling repair work along with a loan to pay for it. The sales pitches tended to be highly scripted and usually deceptive, leaving out basic terms or misrepresenting them altogether. The loans, second mortgages, typically carried high rates, hidden fees, and other onerous terms that were driving residents by the hundreds into foreclosure. This allowed the lender to buy the house from the court for the cost of the loan, usually a fraction of the home’s market price. The practice was seen by regulators and activists as a deliberate ploy to profit from foreclosure and was soon given a name: “equity stripping.”

The sales pattern was centered on African American neighborhoods where residents had bought their homes decades before—often with the help of a government program—and were thus equity-rich if cash poor. Most of the time, the Globe found, the homeowner had never expressed interest in home repair—let alone a loan to pay for it—until a salesman knocked on the door, often repeatedly. Indeed, the salesmen were so persistent that neighbors came up with a name for them, too: “bird dogs.” The scams—some criminal, some merely deceitful—were drawing the attention of community activists and plaintiffs’ lawyers, and eventually public officials, including Massachusetts attorney general Scott Harshbarger and Boston mayor Ray Flynn.

Over the spring of 1991, the Globe began to unravel the ties binding a reputable brand-name bank with the netherworld of American finance—this peculiar market of “Miss Cash” and termite-spreading exterminator salesmen, of pawnbrokers, check cashers, rent-to-own appliance stores, second mortgages, or “second liens,” and the like, all generally known as consumer finance, which would later take on a new name: the subprime mortgage industry.

The year 1968, pivotal in U.S. history for many reasons, upended U.S. housing policy as well. In response to a deposit crisis among banks that was hurting their ability to fund home loans, Congress vastly changed the game with the Housing and Urban Development Act of 1968, which transformed Fannie Mae, started in the New Deal as the Federal National Mortgage Association, from a public-private hybrid agency that bought government-issued loans into a private, federally chartered corporation with a new mission: Buying conventional mortgages from the private market and repacking and selling them to bond investors in the form of mortgage-backed securities. (Its old job of buying unconventional FHA loans was given to a new entity, the Government National Mortgage Association, Ginnie Mae.) Among other things, the move allowed the Johnson administration, then running deficits to fund the Vietnam War, to move Fannie Mae’s giant liabilities off the government’s books. A few years later Congress created the Federal Home Loan Mortgage Corporation, Freddie Mac, to further expand the secondary market. These “government-sponsored enterprises,” or GSEs, quickly ramped up mortgage buying and bundling of prime (thirty-year, fixed rate) mortgages. Modern securitization began in earnest, allowing larger capital markets to directly invest in American homeownership at a lower cost than the older depository-lending model.²

As Bethany McLean and Joseph Nocera and others have explained, in the late 1970s Lew Ranieri and a band of rebellious “fat guys” (so dubbed by Michael Lewis in Liar’s Poker [1989]) on Salomon Brothers’s mortgage desk (as well as other, presumably slender guys at the Bank of America) got involved and helped solve knotty technical and legal problems holding back the mortgage-backed securities (MBS) market, particularly how to handle the borrowers’ right to prepay their mortgage, which was problematic for bond buyers who prefer instruments with a guaranteed, fixed term. Ranieri and his colleagues divided the mortgages into tranches (slices) that they ordered and priced in terms of repayment risk. The advances allowed Wall Street to securitize and trade, at first, nonconventional mortgages, such as “jumbo” loans and adjustable-rate mortgages. The innovations allowed Wall Street banks to bypass the GSEs altogether and buy conventional mortgages without a government guarantee then repackage them as mortgage-backed securities that, with certain credit enhancements, could also earn top AAA ratings from Standard & Poor’s and other rating agencies.3 By the early 1990s, so-called private-label securitization conduits became an entrenched and accepted part of the mortgage finance system. By the end of 1996, the residential mortgage market had grown to $773 billion, with $497 billion of that securitized, about $40 billion of that private label.⁴

Meanwhile, a regime of consumer disclosure gradually replaced the New Deal’s compulsory interest-rate caps and strict prohibitions of risky products. Congress had passed the Truth in Lending Act (TILA) in 1968 to force lenders to provide borrowers with meaningful information about fees, rates, and other loan components, and the Real Estate Settlement Procedures Act (RESPA) in 1974, which prevented under-the-table arrangements between lenders and title insurers, real estate brokers, and other service providers. In the coming years, the U.S. regulatory regime would give the financial-services industry a much freer hand in the types of products it could sell and the rates and fees it could charge.

A key driver of the deregulatory push was inflation in the 1970s, which Nocera rightly identifies as the fulcrum between financial eras. Inflation wreaked havoc on the New Deal’s strict banking-regulatory regime and added force to lenders’ long-standing arguments for more flexibility.5 State legislatures began to repeal or loosen usury laws on their own, and in 1978, the Supreme Court dealt them a severe blow by ruling that credit card companies could charge rates allowed by the states in which their operations were chartered rather than having to abide by local laws prevailing where the products were sold.⁶ South Dakota, Delaware, and other states abolished caps altogether, effectively ending usury caps on credit cards as lenders moved operations to industry-friendly states. Congress allowed lenders to set their own interest rates for mortgages in 1980 with the Depository Institutions Deregulation and Monetary Control Act. The Alternative Mortgage Transaction Parity Act two years later allowed lenders to offer a wider range of products, including adjustable-rate mortgages and balloon payments, that shifted risks to borrowers and demanded a greater degree of sophistication. At the same time, lenders’ newfound flexibility made full and fair disclosure ever more important. Fatally, DIDA also preempted state laws that explicitly barred such products, removing a critical layer of banking oversight.⁷ In 1994, Congress explicitly allowed interstate banking with the Riegle-Neal Interstate Banking and Branching Efficiency Act, creating the conditions for behemoth “too big to fail” banks. The capstone of financial deregulation, of course, was passage of the Gramm-Leach-Bliley Act in 1999, formally repealing the New Deal’s Glass-Steagall Act, which had separated commercial and investment banking. The new act ratified the giant Citigroup merger and cleared the way for a seamless mortgage machine, connecting, as we’ll see, subprime retail sales forces to Wall Street mortgage-trading desks.

In the prime market, securitization worked. For the American middle class, mortgages became cheaper and more readily available. Banks could move a portion of their loans off their books by selling prime, conforming loans to Fannie Mae and Freddie Mac, which bundled and sold them as securities, and by selling jumbo and nonconforming loans to Wall Street, which packaged them and sold them as well. The value of new mortgages issued went from about $35 billion in 1970 to more than $450 billion in 1990 after real estate recovered from a downturn.8 And securitization propelled the growth. By 1996, the mortgage market was around $800 billion with nearly $500 billion of that securitized.⁹ What’s more, for the bulk of middle-class borrowers and for the bond investors who bought stakes in their mortgages, the market was remarkably solid. From the mid-1980s through the mid-1990s, for instance, even during the real estate downturn of that era, delinquency rates hovered in the single digits, while severe delinquencies (more than ninety days past due) were rare, under 1 percent, and foreclosures were even rarer, less than 0.33 percent of total mortgages from 1986 to 1995, according to HUD statistics. The performance of the prime mortgage market and prime MBS from the end of World War II through the 1990s can fairly be called one of the great success stories of American finance.

But what was true of the prime market was never true of subprime. It operated by an entirely different dynamic. As reporters, regulators, plaintiffs’ lawyers, and other insiders would later discover, the market was notable for what economists call severe asymmetries of both information and power. Subprime borrowers, by definition, have fewer choices when it comes to credit than their prime counterparts and, as a rule, have not only less money but also less of what sociologists call “cultural capital,” the nonfinancial assets—educational, intellectual, or social—that tend to promote social mobility. Studies would bear this out, but no one knew it better than the people who worked in the subprime industry. As Bill Runnells, the creator of “Miss Cash,” once said: “When you’re broke, you’ll borrow money at any price.”¹⁰ If the subprime market was not inherently corrupt, it was practically so. Corruption can be defined as wrongdoing on the part of an authority or a powerful party involving immoral means. Subprime lending represents a misalignment of interests, knowledge, and power so profound that corruption becomes inevitable. The difference between loan-sharking and subprime lending is necessarily blurred. This observation has been borne out since the beginning of subprime.

It was here that accountability reporting could play a vital role, and in the 1990s, it did. Regulation now became less about prohibition than about disclosure—the idea being that borrowers, if properly informed, could make their own choices. But that was a big “if,” particularly given the symbolic nature of finance and financial products. What had been a stable—if unfair—mortgage market became far more volatile. A new dynamic set in as a new generation of sophisticated financial players sought to exploit widening opportunities among a new borrower class defined by its financial vulnerability and its lack of sophistication. Meanwhile, accountability journalism and regulation—both still powerful in their own right—found themselves in the symbiotic relationship of exposure and enforcement, enforcement and exposure. Regulatory investigations and actions created protected documents that reporters could use safe from libel and other legal concerns to expose wrongdoing at the bottom of the financial system. Reporters could on their own initiative use tips, lawsuits, and data from the plaintiffs’ bar, community groups, and borrowers to advance original investigations, which regulators could then use to make cases.

It should be noted that early creators of mortgage securitization never contemplated that risky subprime mortgages would ever be a part of the market. The financier Larry Fink, who helped create the security at First Boston in the 1980s, dismissed the idea out of hand in testimony to Congress at the time: “I can’t even fathom what kind of quality of mortgage that is, by the way, but if there is such an animal, the marketplace … may just price that security out.” In other words, investors would demand such a high yield as to make such a deal untenable.11

Along with shifting Fannie Mae’s mission to buying and packaging prime mortgages, the Johnson administration housing law also created the nation’s first formal subprime loan program through private lenders. Tellingly, it ran aground almost immediately after borrowers in the program complained of fraud. As the historian Louis Hyman writes, “In an eerie prefiguring of the 2000s, the subprime lending program soon fell apart as predatory lenders and unscrupulous house flippers defrauded first-time buyers.” The government found itself insuring defaulted mortgages on houses that could never be resold. The Nixon administration was forced to freeze the program in 1971.¹²

Congress made another pass at redressing the lingering problem of lending discrimination in 1977 with the Community Reinvestment Act, giving regulators the power to deny merger applications of banks found to have failed to meet the credit needs of low-income groups in their service areas. The law was generally deemed ineffective (notwithstanding its later, mistaken assignment by conservatives as a cause of the mortgage crisis). For decades, inner-city residents, even creditworthy customers, couldn’t get mortgage credit at any price.

Regional newspapers, then approaching the apogee of their power, would play a key role in combating the problem known as “redlining,” a potent term of disapprobation. In 1988, for instance, the Atlanta Journal-Constitution published “The Color of Money,” a four-part series that found that whites received five times as many home loans from Atlanta’s banks as blacks and that race, not income or home values, “consistently determined lending patterns.” One of a number of celebrated press investigations into redlining, the series included devastating side-by-side maps that showed that areas of high African American concentration and low lending were virtually the same. The series, by twenty-seven-year-old reporter Bill Dedman, won the 1989 Pulitzer Prize for investigative reporting. Other papers followed suit. The Wall Street Journal, for instance, ran a lengthy Page One story in 1992 based on its own study of Federal Reserve data of 9,300 banks that found that blacks were more than twice as likely to be rejected for home loans as whites and that some black communities remained virtually mortgage-free zones.13

Soon, though, a new kind of mortgage lending would begin to fill the void left by redlining. This new practice had its roots in the consumer-finance industry and was expensive, deceptive, and heavily marketed. Indeed, its defining characteristic was that it was, in Wall Street parlance, “sold, not bought.” In other words, customers typically don’t seek out high-cost financial products, and a high degree of salesmanship was required to move them. In this sense, subprime lending would turn traditional banking on its head. Whereas banking emphasizes underwriting and risk analysis, subprime lending became an exercise in salesmanship. The highest accolade for a mortgage salesman was a single word: “closer.”

Activists struggled to find as effective a term as “redlining,” which vividly described areas of no credit, to capture this new, toxic brand of lending. To describe it, they believed, would also condemn it, and if it could not be entirely eliminated, it could at least be contained. The failure to find an effective name for this form of lawless lending would seriously hamper the press’s attempts to cover it. In a linguistic study of the press and the financial crisis, “How ‘Subprime’ Killed ‘Predatory,’” Elinore Longobardi traces media use of the two expressions and documents how and why the former, industry-sanctioned term for high-cost, high-risk, heavily marketed lending, “subprime,” overtook the activist-generated term, “predatory.” The latter suffers, while accurate in its way, from being both rhetorically aggressive and, at the same time, vague and ill-defined. This combination of lack of clarity and strong rhetorical punch meant that much of the press—and especially the business press, which already tended to underplay consumer issues—remained uncomfortable with the term, even after years of use, and so ultimately gravitated toward the far more industry-friendly “subprime.”14

Scholars in the 1990s also struggled to define what was then seen as a rising problem among the poor and the elderly. Modern Maturity magazine, for instance, offered this definition: “A loan company is considered predatory … when it makes a loan that a borrower can’t repay.”¹⁵ Allen Fishbein and Harold Bunce, in an article on subprime growth and predatory lending, discussed the problem of definition.

The term ‘predatory lending’ is a shorthand term used to encompass a wide range of abuses. Although there is broad public agreement that predatory lending should have no place in the mortgage market, there are differing views about the magnitude of the problem and even how to define practices that make a loan predatory. Although home mortgage lending is regulated by State and Federal authorities, none of the statutes and regulations governing mortgage transactions provides a definition of predatory lending.

A big problem with the term—one that hampered media coverage—is that it seeks in a single phrase to define a range of interpersonal interactions, from offering (false) assurances that the buyer can refinance before rates go up, misrepresenting basic terms, failing to include escrow costs in payment schedules, colluding with appraisers, changing terms at closing, forging signatures, and more. In short, these are very human situations that involve would-be borrowers eager to obtain a loan, either for a new home or, much more often in the case of subprime, to pay off other debts; a loan sales force incentivized to make as many loans as possible as quickly as possible on, as we’ll see, the most onerous terms possible; appraisers incentivized to provide estimates that would support the loan; and telemarketers provided scripts that downplay risks, interest rates, and fees and focus instead on initial monthly payments. It’s not surprising, then, that activists struggled to find a single term. It’s a long conversation. As Longobardi observes,

Opponents of lending regulation used the vagueness of “predatory lending” to defeat attempts to police it. In response to forceful warnings from a major 2000 joint HUD and Treasury Department report on the problem, Senator Phil Gramm, then head of the Senate Committee on Banking, Housing, and Urban Affairs, directed staff to report to him on “what the regulators refer to as ‘predatory lending,’ and what they see as the extent of the problem.” The five-page staff report, prepared in only a couple of months and released in August 2000, concludes,

The subprime lending industry initially preferred the even more neutral term “non-prime,” to describe itself, according to the Center for Responsible Lending’s Martin Eakes, but for investors in the lenders, “subprime” is more exact. Initially, even borrower advocates embraced the term “subprime” and encouraged the distinction from “predatory.” Advocates hoped that the relatively new industry would live up to its perennial promises of reform and provide low-income borrowers a fair chance at credit and so didn’t want to stigmatize all such lending, which, by its nature, is costlier in order to offset the higher risk. The industry, along with public officials, also encouraged the distinction between “predatory” and “subprime” to convey their belief that problems in the subprime industry were not widespread but rather just a matter of a few bad apples. Eventually, however, from the advocates’ point of view—and in fact—such fine distinctions would be overwhelmed by the realities of the market. For all intents and purposes, one became a synonym for the other.

The sharp jump in what I, for the sake of simplicity, will call subprime lending was driven by economic distress of the early-1990s recession. A major HUD/Justice Department report in 2000 specifically traces its rise to borrowers consolidating rising credit-card debt into mortgages, a practice encouraged by the 1986 tax reform law that had left mortgage interest the only consumer debt allowed as a tax deduction.19 Meanwhile, new money was flooding into the industry as Wall Street refined ways to securitize subprime debt—ironically, with the government’s help. The Resolution Trust Corporation, created to clean up the S&L debacle, found itself saddled with motley collection of assets—office buildings, malls, vacant lots—that brought in lease payments but didn’t conform to the standards of the main securitizers of the day, Fannie Mae and Freddie Mac. The RTC, in an effective move, allowed Wall Street to find new creative ways to obtain AA or AAA ratings for their securities without the GSEs by adding what became known as “credit enhancements.” These could include extra collateral, insurance from third parties, and (later) a senior/subordinated structure where the cash flows from underlying mortgages went to “senior” holders first, minimizing their risk. The agencies rated some of the instruments AAA, allowing conservative investors, like pension funds, to buy them.²⁰ The infrastructure of a subprime boom was falling into place.

As with the first subprime program of the late 1960s—and in volumes not seen in the prime market—consumer horror stories began to pile up almost concurrently with the subprime boomlet of the early 1990s. Plaintiffs’ lawyers and community activists complained that big banks, often acting through unethical mortgage brokers, used deceptive tactics to engage in equity stripping. Among the pioneers on the national scale was Fleet.

With roots dating to early American history, Fleet, which started as the Providence Bank and later became the Industrial Trust, was one among a handful of staid, Yankee-dominated institutions that long dominated Rhode Island economic and social life.21 After changing its name to the market-tested Fleet Financial Group, the bank in 1982 hired a hard-charging and decidedly gruff CEO, J. Terrence Murray, who almost immediately took advantage of loosening banking laws to acquire smaller banks around the region. (Among his key aides was a lawyer, Brian Moynihan, now CEO of Fleet’s mega-bank successor, Bank of America.)²² Within three years, Fleet was operating in thirty-three states, and Murray had acquired a reputation as a master of creating efficiencies, albeit a ruthless one. Fleet managed to diversify its revenue sources to the point that it weathered the catastrophic real estate crash that followed the S&L debacle in the late 1980s far better than many of its competitors. As the 1990s dawned, Fleet and Murray were Wall Street darlings.

One of the bank’s crown jewels, as far as Wall Street was concerned, was its Fleet Finance unit, which specialized in high-interest, high-risk retail lending. In 1990, when banking generally was in a slump and Fleet as a whole posted a loss for the year, Fleet Finance rang up healthy profits of $60 million. A key part of its business was serving an important secondary market for smaller operators around the country who made loans to borrowers with impaired credit and other suboptimal customers. Fully 60 percent of the loans on the unit’s books in 1990, 40,000 loans, had been purchased from smaller operators. Fleet itself was not shy about its reliance on the second-mortgage business. “This is a huge business for us,” a bank spokesman, Robert W. Lougee Jr., said of the Fleet Finance unit in 1991. “We have a large appetite for purchasing loans.” Indeed, it was Fleet Finance’s performance that would enable its parent to buy the assets of the failed Bank of New England in 1991, an acquisition that would make it the region’s largest bank and launch it on the national stage. It would soon control 30 percent of deposits in the region and, at the time, it seemed unstoppable.²³

But American newspapers were powerful then, too. The Globe, in particular, owned by a public company but managed by descendants of the prominent Taylor family since the nineteenth century, held enormous sway in New England and Providence. It was considered one of the nation’s top papers and one of a handful of preeminent regional standouts. Its hundreds of reporters and photographers roamed the world and had already won a dozen Pulitzer Prizes for work as varied as photographing famine in Ethiopia, analyzing foreign policy in the nuclear age, and a widely praised examination of local racism that included criticism of the paper itself. The paper’s Spotlight Team, created during the investigative renaissance of the 1970s, had won Pulitzers for unearthing corruption in Somerville and gross mismanagement of the city’s transit authority. Soon the region’s most powerful newspaper would be going toe-to-toe with the region’s most powerful bank.

Led by Canellos, then twenty-nine years old and assigned to the metro desk, the Globe performed a classic newspaper investigation. It started small, drawing on the work of housing activists and plaintiffs’ lawyers who were using the merger-blocking provisions of the Community Reinvestment Act (then taken more seriously than it is today) to call attention to Fleet’s connection to the unethical lending practices of smaller mortgage brokers and lenders in Boston’s minority neighborhoods and suburbs. As it unfolded in the spring and summer of 1991, the probe expanded further to encompass other brand-name players tied to the poverty industry. As one headline put it, “Mainstream Banks Have Ties to Above-Market Deals” (May 9). The Globe’s gaze expanded even further to regions outside Boston, first Atlanta then Chicago, New York, Phoenix, and elsewhere. On June 9, Canellos printed a 2,700-word story that zeroed in on Fleet’s practices in Atlanta. The story described the frenzied behavior of loan salesman who fanned out through African American neighborhoods looking to sell home repairs and the loans needed to make them: “Margaret Wright Gay, a resident of northeast Atlanta, maintains that she never wanted any repairs on her house—especially not at the inflated price being offered by the contracting company whose representatives, she said, woke her up for a week running about a year ago by banging on her door early in the morning.”

The story spread to other news outlets, including the Boston Herald, the Globe’s rival, which, to its credit, didn’t downplay the story but tried to advance it. The Atlanta Journal-Constitution dealt another blow to Fleet’s wounded reputation with an exposé called “The Loan Trap” (November 11, 1992). Reporter Jill Vejnoska told the story of a sixty-two-year-old suburban grandmother, Lillie Mae Starr, a packer for a local tea company earning $300 a week, who was fighting foreclosure after taking out a $5,000 loan to repair her windows. It turns out the loan included almost much in fees as in principal, and carried a 23 percent interest rate. She couldn’t afford the payments the day the loan closed and, after various refinancings, owed $63,000. “All Lillie Mae Star wanted was a chance to stay warm,” the 3,300-word story began.

Michael W. Hudson came across the Globe series while researching his poverty project for the Roanoke Times. In those pre-Internet days, he had asked a news librarian to search clip files and online databases and noticed a wire story with reference to the “Boston second-mortgage scandal.” He called the National Consumer Law Center, a nonprofit antipoverty advocacy group in Washington, which sent back a stack of clips, most of them from the Globe about Fleet. Seeing the nascent subprime business as a national story, Hudson pitched freelance pieces about it to national liberal magazines. His “Stealing Home” (Washington Monthly, June 1992) told the story of Roland Henry, an eighty-four-year-old Los Angeles man with a sixth-grade education who had made his living selling tamales on street corners. Confined to a wheelchair and nearly blind, he took out home-equity loans to buy carpet, then was talked into a high-interest consolidation loan by a man later charged with thirty-two felony counts of fraud. Using the telephone and the U.S. mail, Hudson tracked down court records from a widening network of regulators, lawyers, and advocates from around the country to show that the anecdotes were part of national pattern. Soon after the story was published, Hudson got a call from a producer at 60 Minutes who had seen the Washington Monthly piece and wanted to work on a segment to be reported by Morley Safer. In November 1992, 60 Minutes, which had long used regional papers’ investigative work for story ideas, aired a piece examining Fleet Financial’s practices in a working-class neighborhood in Atlanta. This was a scathing piece that maximized the power of television: authoritative voiceovers, deft cuts, and devastating on-camera admissions. The piece interviewed not just borrowers, but such actors as an unlicensed broker, a bird dog (“I’m not a salaried person. I just—I—I get up there every day and go out and find business”), and the owner of a “dwarf,” the small lender that sold loans to Fleet, who breezily admitted he was just a proxy for the bank.

Among those quoted in the story is Roy Barnes, a successful plaintiffs’ lawyer and state legislator, who, as it happens, also had made millions starting a small-town bank in nearby Cobb County.²⁵ Barnes had started his career as a conservative, voting in favor of removing interest-rate caps on loan, but later had come to regret the vote. He pointed to Fleet’s obvious role as funder and beneficiary of abusive loans: “This is so egregious, so wrong, that everybody tries to create this barrier and say, ‘My hands are not dirty.’ Well, you can’t be in this business and you can’t look at these loans and say that Fleet’s not responsible. They had to know what was going on. They had the profits, they had the pre-approval, they had the connections and they knew that the yields were great.”

Fleet issued angry denials, including that it had any control over the “seven dwarves.” Still, the 60 Minutes story triggered an uproar. A Globe story said dozens of people called Atlanta’s legal-aid office saying they had experienced flimflams similar to those described in the piece. Fleet fielded more than a hundred calls. Rep. Joseph P. Kennedy II, a member of the powerful House Banking Committee, soon issued a call for hearings.

But by that point, Fleet was already in full retreat. Shortly before the 60 Minutes piece aired, the bank, which had already settled fraud charges in Massachusetts, had announced a $38 million “restitution” program for Georgia residents at a ceremony with Atlanta mayor Maynard Jackson. The bank claimed it would revamp its subprime unit and cease doing business with the “dwarves.” Its rhetoric—even its spokesman—had changed. Fleet’s CEO, Murray, “wants to do the right thing,” a new bank spokesman said. “The commitment is real. We want to get this issue behind us.”26

The press did not act on its own to expose Fleet’s wrongdoing. It was part of a dynamic that, as in many cases, included plaintiffs’ lawyers, state and local regulators, and political figures, including the mayors of Boston and Atlanta. A key figure then (and a decade later during the mortgage era) was William J. Brennan Jr., an Atlanta legal-aid lawyer who served as an information clearinghouse and source for journalists. Stories from the Globe, the Journal-Constitution, and 60 Minutes were part of a virtuous dynamic of reform—a three-way reverberation among press, regulators, and the public that contributes to collective understanding and creates the context for collective action.

By February 1993, Congress had taken up the issue, and Fleet bankers were called to testify before the House Banking Committee. They were abject in their contrition. The next year, Congress passed and President Clinton signed the Home Ownership and Equity Protection Act (HOEPA), authored by Kennedy and targeting “predatory lending.” The law barred some egregious loan terms (e.g., many prepayment penalties) altogether and required additional disclosure for loans deemed “high-cost,” meaning those with first-mortgage rates of more than eight points over current Treasury yields or fees exceeding eight percentage points of the principal. The law gave the Federal Reserve increased powers to police lawless lending. However, in retrospect, the law is not considered a success because “very few consumers benefit from the law’s subprime provisions,” according to the 2000 HUD-Treasury task force, mainly because the rate and fee thresholds were set too high; most subprime lenders evaded the law by setting these just below the limits.27

But for purposes of examining the financial crisis and the financial press, the history of this now-forgotten law is significant for several reasons. First, in light of what was to come a decade later, it’s important to remember that HOEPA was first and foremost a law about disclosure. Indeed, it was an amendment to the 1968 Truth in Lending Law. Its most onerous provisions, from the banking community’s point of view, were those that required the lender to disclose clearly and in a timely manner such basic information as the interest rate, monthly payments, and whether and how these would change under the terms of the contract. In other words, HOEPA was designed to give amateur borrowers a chance to understand what they were signing, and it was this provision that the mortgage industry fought so vigorously. By lowering interest rates just below the threshold that triggered the law, lenders demonstrated that they were willing to forgo yield in order to avoid clear disclosure.

Second, as bad as it already was in the early 1990s, the subprime industry was still a threat only to borrowers desperate enough to need it. At a few billions loaned a year, it was a speck compared to what it was to become in the just the next few years, never mind the era of extreme corporate lawlessness that would overtake the mortgage industry during the 2000s. Before 1994 subprime lending was a negligible portion of the overall mortgage market with a nominal amount securitized. By 1994, however, the subprime total had risen to $35 billion, about 4.5 percent of the overall mortgage market, about a third of which was securitized. By 1998, it was up again by half, to $150 billion, more than half securitized, and would remain more than 10 percent of the mortgage market through the decade.28

Third, HOEPA represented a press victory, albeit an incremental one. Investigative reporting by mainstream news organizations, then at the height of their power, had exposed rampant abuses and brought them to the public’s attention. The truly crooked operators were policed, and a major financial institution was brought to heel. Broadly speaking, when Big Journalism took on Big Finance, journalism won, and won handily.

Fourth, journalism in the early 1990s showed that it was quite capable, without much specialized knowledge, of tracing, explaining, and ultimately policing not only retail lenders involved in loan fraud and misrepresentation but also their links to mainstream finance. In this case, Fleet represented both the funding source and the aftermarket for lawless loans, the same basic model that would be in place—on a vastly larger scale—ten years later during the mortgage era. Instead of dwarves, the reckless and unethical lenders would become Countrywide, Ameriquest, IndyMac, Washington Mutual, New Century, and Citigroup. Instead of Fleet, the aftermarket would be made up of Merrill Lynch, Bear Stearns, Lehman Brothers, Goldman Sachs, Citigroup (again), and a small handful of others. The names changed, but the model remained the same. It’s true that the aftermarket would become considerably more complex in the later era and that the lawless loans would be put to far more dangerous use in the global financial system. But that’s all the more reason to understand the nature of the lawless loans in the first place.

Hudson delved deep into the consumer-finance sales culture and got to know the salespeople, mostly men, who, it turns out, formed a veritable brotherhood, with its own language, mores, and pantheon of heroes. Hudson heard stories of legendary “closers”—experts in the arts of suasion, reputed to be able to convince customers to sign almost any loan, no matter how onerous. He learned the tricks of burrowing into the psyches of the anxious janitors, nurse’s aides, and restaurant workers who had the bad luck to wander into these salesmen’s offices or were unable to put down the phone when cold-called at home. He read their literature, books with titles like Creative Visualization and Persuasion (“a very dangerous book as far as the information in it,” one loan salesman explained to Hudson). One famous sales script written by First Alliance Mortgage, one of the industry’s most notorious, was called “The Track” and was legendary for its ability to lead the salesman to a customer’s vulnerabilities. Sales reps called it “Finding the Pain.”29

He learned that top salesmen knew that the best times to close loans were either late at night, between eight p.m. and midnight, when borrowers were bleary-eyed, or during their harried thirty-minute lunch break. Hudson learned colorful terms, such as the one for pressuring panicky borrowers caught in a refinancing spiral: “nut-squeezing.” Among time-tested nut-squeezers: showing up at a debtor’s house with a couple guys from the office a couple days before Christmas, threatening to pack the tree and drive the family to spend the holiday in hotel.30

He picked up the subprime industry maxims, true insights into popular culture. As one salesman told him, “Eighty percent of Americans are two paychecks away from subprime,” Another said, “If you don’t find the true pain, you won’t make the loan.”³¹ He came to understand that the subprime lending culture had nothing do with traditional banking values, like underwriting and risk analysis. It was a sales culture and all about one thing: closing. And it was hard-partying and louche. One sales manager handed out crystal meth to keep his staff alert; another made the low producers keep a plastic pile of dog shit on their desk until they boosted sales; a third, to make sure his staff wasn’t going easy on borrowers, planted electronic eavesdropping devices in their offices (“We would listen in, such as the telephone company and various other large organizations do, you know,” he would testify). Another subprime owner took a more positive approach and gave top producers time inside a “money machine,” a small room into which a tornado of cash was blown; loan officers kept whatever they could grab.³²

The insight Hudson was gaining was that the subprime business was not an ordinary market—not, as Wall Street financial modelers would later assume, a somewhat “riskier” version of the well-established prime mortgage market. Subprime was where the least sophisticated met the most ruthless. Subprimers were more ruthless because their risks were, in fact, greater. Everyone, in fact, did have a sob story. Default rates were higher in subprime, as a matter of course. (Comedian Jon Stewart captured the subprime dilemma with this quip during a bit in 2008: “Absolutely, and if you’re going to give money to people who have a tough time paying it back, charge them more. It makes total sense.”) By the same token, subprime products were, by definition, inferior. Rates were higher. Fees were higher. No one asked for a subprime product. These did not sell themselves. The only reason anyone would accept a subprime loan was because either they had no alternative or they didn’t know any better. During the 1990s, the numbers of both types of customers were growing, but it was in the second category where subprime lending melded with predatory lending to the point of being indistinguishable. Subprime is the definition of what economists might call an asymmetrical transaction, where one side had the money, the leverage, and, most important, the information. It was in this netherworld of misrepresentation and misunderstanding, feints, fakes, winks, nods, forgeries, buried “good-faith estimates,” nondisclosure, semidisclosure, sort-of disclosure, insincere reassurances, and bald-faced lies that the true essence of subprime salesmanship could be found. This was where the art happened.

In his reporting, Hudson came across evidence that the lawlessness was out of control. An Alabama jury hit Associates with a $34 million verdict, including punitive damages, for forging borrowers’ names, then foreclosing on their homes. (A judge ordered a retrial, ruling that he shouldn’t have allowed a plaintiff’s lawyer to describe Associates as a “company without conscience.” The company later settled.) It paid another, undisclosed sum to settle forgery allegations in Seattle. The company settled cases around the country after having been discovered to have slipped costly credit insurance into deals without telling borrowers or after telling them it was mandatory.33

It was on this story that Hudson learned the value of a particular kind of source: the whistleblower. Invariably former employees, these were people who challenged the lawless culture of their employers and typically were pushed out or fired. These outcasts were never perfect as sources—often they were bringing suits against their former employer (that’s how Hudson found many of them)—but they provided eyewitness testimony from within the bureaucracy, testimony that was usually included in court filings, which provides journalists with a measure of legal protection. Hudson would become a master of tracking down and cajoling whistle-blowers. He mined court records for employment cases and tracked down the plaintiffs at home. In many cases, he found through word-of-mouth remorseful former employees who hadn’t sued the company and convinced them to talk. Since the subprime business was centered in Southern California, and Hudson lived on the East Coast, he could catch them at home after hours, allowing him to extend his reporting day until almost midnight.

In this case, he found an unimpeachable source in the person of Philip White, a Gulf War veteran who had come home to Alabama in 1991 and taken a job as an Associates loan officer. Within months, he told Hudson, he felt misgivings about what his bosses told him to do. One hard-and-fast rule at the company, for instance, was to never tell the whole truth, unless it becomes absolutely unavoidable. “‘If you don’t have to tell them, and they don’t ask, don’t tell them. Just get ’em to initial it. They can read—most of them anyway,’” White told Hudson he knew personally of twenty to twenty-five instances in which customers’ signatures had been forged on truth-in-lending disclosure forms mandated by the 1968 federal law. As the months dragged on and customer after customer called to express shock that their payments were much higher than they had been told they’d be, White finally quit. The pressure to produce, he told Hudson, forced ordinary people to do things they would never normally do. “Some of the people there are very nice. [But] they’re put under such pressure to produce to profits that everybody knows what’s going on. … The people are good but they do things they don’t want to do.”34

Within a few years, Associates would go on to earn one of the most notorious reputations in the subprime industry. The Wall Street Journal would describe how an illiterate quarry worker who owed $1,250 for—of all things—meat discovered that his consumer loan had been sold to Associates, which convinced him to refinance ten times in four years until he owed $45,000, more than half of it in fees, with payments that took more than 70 percent of his income. He had signed each note with an “X.”³⁵ Associates’ abuses—it employed a “designated forger,” ABC’s Prime Time Live would confirm on April 23, 1997—were so extreme that it would be credited with spurring the North Carolina legislature into passing its pioneering antipredatory-lending law, in 1999. Indeed, Hudson found that the tin men and other flimflam artists almost always worked in partnership with finance companies, which, in turn, were invariably owned by brand-name corporations, CitiBank, Chemical Bank, BankAmerica, NationsBank, and others.

In mid-1996, Hudson edited Merchants of Misery: How Corporate America Profits from Poverty and wrote four of the ten chapters, including a long one documenting forgery and fraud accusations against Associates called “Signing Their Lives Away.” Other chapters looked at payday lenders, rent-to-own operators, pawnshops, check cashers, home-repair scammers, trade-school scams, and so on. The introduction, by Hudson, expressed astonishment that such low-rent operators as Associates could be underwritten, or owned outright, by some of the most respected names on the New York Stock Exchange: “More and more, the merchants who profit from the disadvantaged are owned or bankrolled by the big names of Wall Street: Ford, Citibank [now Citigroup], NationsBank, BankAmerica [both now part of Bank of America], American Express, Western Union. … Add up all the businesses that bottom-feed on the ‘fringe economy’ and you’ll come up with the market for $200 billion to $300 billion a year.” Besieged by bad press, Ford had sold a portion of Associates to the public in an initial public offering in 1996 and spun it off altogether two years later, when Associates was examined by yet another congressional panel on predatory lending, this time the Senate Special Committee on Aging. But despite lawsuits and regulatory action, Associates continued to be immensely profitable. In 1999, it completed its twenty-fifth consecutive year of earnings growth, posting a net income of $1.5 billion on about $100 billion in assets. It operated more than 1,500 retail offices around the country and boasted 800,000 customers. Yet because of its down-market niche and notorious reputation, it remained on the margins of the financial system. But that would soon change.36

In his classic article, “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism,” published in the Quarterly Journal of Economics in 1970, the economist George Akerlof highlighted the power imbalances and market inefficiencies that occur when one party lacks either information about future performance of the agreed-upon transaction or the ability to retaliate for a breach of the agreement. Akerlof’s paper cited the market for used cars for its discussion of the problem of how defective products (“lemons”) are sold by more-knowledgeable sellers to less-knowledgeable buyers in a lightly regulated market. The result, of course, is that transactions go awry. But more, Akerlof concluded, the dynamic wrecks the market itself by creating a situation in which cheaters prosper, and in fact cheaters alone can prosper. Because buyers can’t be certain of the quality of the product, prices will reflect their uncertainty. In the cases of used cars, the owners of good cars, unable to command a fair price, will withhold their cars from the market. “The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.”³⁷

William K. Black, a former top federal regulator during the S&L cleanup and an associate law professor at University of Missouri–Kansas City, has coined the idea of “criminogenic environment,” conditions that foster a culture of lawlessness. In a 2010 interview, he says bad money drives out the good, also known as a form of Gresham’s Law:

What the regional reporters such as Hudson understood was that informational asymmetries are much more profound in the subprime market than those found among prime borrowers, who themselves are often lost in the stack of paperwork to be signed at closing and the many moving parts of a typical mortgage. Lenders, after all, are the professionals in the transaction, and borrowers, the amateurs.

Steve Eisman, a Harvard Law School graduate with an antisocial streak, quit his job as a corporate lawyer in 1991 and went to work as a junior analyst for Oppenheimer Funds, an old-school Wall Street partnership where candor about public companies was still permitted. Eisman acquired a reputation as an odd duck and not given to social niceties. Once, meeting with a executive of a Japanese company, Eisman held up the company’s financial disclosure and pronounced it “toilet paper,” as recounted in Michael Lewis’s The Big Short, the celebrated post-crisis book that chronicles the Wall Street subculture—or more exactly, counterculture—that saw subprime lending for what it was. When he started on Wall Street, the first wave of “specialty lenders” was going public, and Eisman was assigned to write a report about one of them, Lomas Financial Corp. Eisman looked at its financial statements, the quality of its loans, and its accounting and quickly came to a conclusion: “I put a sell rating on the thing because it was a piece of shit,” Eisman recalls.39

Eisman would make specialty finance something of a specialty of his own and at first, like many market observers, had high hopes for the idea of securitized subprime loans, the linking of Wall Street to America’s lower middle class. Making global capital pools available to people with less-than-perfect credit would allow them to shift debt from high-interest credit cards to low-interest mortgages, so the argument went. Eisman saw it as a rational response to growing income inequality, which he saw as creating a growing need for subprime products.

But it didn’t take Eisman long to detect problems in the model. For one thing, the lenders sold many of their loans to other investors, repackaged as mortgage bonds. In essence, lenders were selling a product but had no interest in its ultimate performance. That was the shadow darkening the good idea. He also noticed that subprime borrowers had astonishingly high default rates, which, in turn, indicated problems with underwriting. Even more alarming for stock investors, Eisman found that the default rates had been covered up by misleading accounting entries and euphemisms, such as “involuntary prepayments.” Eisman collected data from Moody’s (available, by the way, to financial journalists, as well) and concluded that the companies were basically Ponzi schemes, making loans on onerous terms that were certain to result in default but that allowed the firm to collect more money from investors before they did. Accounting manipulation prolonged the scheme by delaying the inevitable.

In September 1997, Eisman came out with a scathing report that said as much, exposing the entire sector of subprime loan originators and creating, in the words of a colleague, “a shitstorm” in the industry. The originators argued strenuously that his data were wrong. But they held up. As it happens, the early subprime firms were all soon wiped out when the global financial crises—which began in Russia and was caused by the Long Term Capital Management hedge fund—shut down their access to credit, sending most of the sector into bankruptcy. In a sense, Eisman was vindicated, but the mass failure obscured the deeper problems in subprime. The sector’s failure was chalked up to the credit crisis and to aggressive accounting, which allowed the lenders to record profits before they were realized. What no one understood, Lewis writes, was “the crappiness of the loans they had made.”40

The 1998 wipeout of smaller lenders, however, did not impede the rise of subprime overall. That year, in fact, subprime originations increased to $150 billion, up from $125 billion the year before, and under $100 billion in 1996. Subprime in the mid- and late 1990s was now more than 10 percent of the overall mortgage market and, after a dip in the early 2000s, would begin to soar. The market was still dominated by old-line lenders, including Conseco, a former insurer that had diversified and bought Green Tree Financial in 1998; ITT Industries, a successor to the old phone company that had diversified in the 1960 and later entered specialty finance; and Transamerica Financial, which had begun as an offshoot of San Francisco’s Bank of America in the 1920s.

The most important player was Household International, parent of Household Finance, which was started in the nineteenth century by a Minneapolis jeweler who made small personal loans, allowing customers to pay off purchases in small increments. By the 1990s, it had become the leading national specialty lender, moving into second liens and in 1998 buying a struggling rival, Beneficial Finance. Soon its lending practices would attract attention of investigative reporters, regulators, and, in New York, Eisman and other contrarian investors.