Chapter 41: Chapter 41
omething 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.
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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 governmentissued 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
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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
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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 unremarked 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.