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Why did blue-chip Goldman take a walk on subprime's wild side?
ABOUT THIS SERIES
A five-month McClatchy investigation reveals how Wall Street colossus Goldman Sachs peddled billions of dollars in shaky securities tied to subprime mortgages on unsuspecting pension funds, insurance companies and other investors when it concluded that the housing bubble would burst.
By Greg Gordon | McClatchy Newspapers
Goldman Sachs was one of the last Wall Street giants to enter the subprime lending world, but when it did, it quickly climbed into bed with profligate, highflying firms â companies such as New Century Financial Corp.
In at least nine deals from 2002 to 2007, Goldman sold bonds backed by more than $5 billion of New Century's mortgages, one even after the California lender's underwriting criteria all but disintegrated and a cash squeeze paralyzed its operation. Goldman also marketed at least three secret offshore deals bearing New Century's name.
By Greg Gordon | McClatchy Newspapers
IRVINE, Calif. â Goldman Sachs was one of the last Wall Street giants to enter the subprime lending world, but when it did, it quickly climbed into bed with profligate, highflying firms â companies such as New Century Financial Corp.
In at least nine deals from 2002 to 2007, Goldman sold bonds backed by more than $5 billion of New Century's mortgages, one even after the California lender's underwriting criteria all but disintegrated and a cash squeeze paralyzed its operation. Goldman also marketed at least three secret offshore deals bearing New Century's name.
Goldman has yet to explain why it risked its blue-chip reputation and financial health to buy and repackage at least $135 billion in loans mostly originated by companies that have since gone bust.
Goldman spokesman Michael DuVally stressed, however, that the firm "was not the largest purchaser of loans from any of these mortgage originators, and in some cases was actually quite a small purchaser."
A glimpse inside New Century's operations sheds light on how one of Wall Street's proudest and most prestigious firms helped create a market for junk mortgages, contributing to the economic morass that's cost millions of Americans their jobs and their homes.
Perhaps no mortgage lender was more emblematic of the go-go atmosphere in the sprouting industry that was seizing an outsize share of the home loan market.
Traversing the country in private jets and zipping around Southern California in Mercedes Benzes, Porsches and even a Lamborghini, New Century executives reveled as the firm's annual residential mortgage sales rocketed from $357 million in 1996 to nearly $60 billion a decade later.
To be a subprime lender at the industry's height was to join in a dash for cash, and New Century was an Olympic-caliber sprinter.
Its top five officers, who received nearly $40 million in salaries and bonuses from 2002 to 2005, could peer out the 10th-floor windows of their gleaming onyx headquarters in Irvine and see the offices of more than a dozen rivals.
"A friend of mine said you couldn't fire a .22-caliber rifle and not hit a subprime lender in Orange County," recalled a former manager of a company that reviewed subprime loan files before Goldman and other Wall Street firms bought the mortgages.
For $100 million in mortgages, New Century could command fees from Wall Street of $4 million to $11 million, ex-employees told McClatchy. The goal was to close loans fast, bundle them into pools and sell them to generate money for the next round.
Inside the mortgage company, the former employees said, pressure was intense to increase the firm's share of an exploding market for mortgages that depended almost entirely on Wall Street's seemingly unlimited hunger for bigger, faster returns.
Michael Missal, a federal bankruptcy examiner who investigated New Century's operations after it sought Chapter 11 protection on April 2, 2007, reported last year that the firm's lax lending and accounting standards "created a ticking time bomb" as it pushed for ever-higher loan production.
The incentives for high-risk behavior reached all the way to Manhattan.
Goldman and other investment banks could put $20 million in the till by taking a 1 percent fee for assembling, securitizing and selling a $2 billion pool of mostly triple-A rated bonds backed by subprime loans â and that was just stage one.
Goldman entities earned millions of dollars more by servicing many of the loans and arranging sophisticated interest-rate swaps to guard against inflation.
As profits poured in, Wall Street firms extended lines of credit to New Century â known as "warehouse loans" â totaling billions of dollars to finance the issuance of more home loans to other marginal borrowers. Goldman Sachs' mortgage subsidiary gave the firm a $450 million credit line.
As the economy slowed, the mortgage industry couldn't keep up with Wall Street's loan demands, but that actually generated leverage.
Kevin Cloyd, the New Century executive vice president who dealt with Wall Street and in 2006 also oversaw loan production, told examiner Missal that a tacit understanding developed with Wall Street firms that were trying to edge out each other for loans, said a person familiar with Missal's inquiry.
Cloyd revealed that investment banks willing to scale back their scrutiny of mortgage applications got to buy more loans, said this individual, who declined to be identified because the material is confidential.
Reached at his Los Angeles home, Cloyd declined to comment.
The former project manager who oversaw the review of tens of thousands of subprime mortgages for Goldman and other Wall Street firms said that in 2005 and 2006, subprime lenders gradually got investment banks to reduce the percentage of loans that were reviewed before deals closed.
"It went from 100 percent in the late '90s to probably less than 10 percent in 2006," said the ex-manager, who declined to be identified for fear that it would hurt his career.
By pitting firms such as Lehman Brothers, Bear Stearns, Credit Suisse and Goldman against each other for a shrinking supply of loans, mortgage bankers were able to sell loans in which borrowers' ratios of debt to income inched up to 50 percent, to 55 percent and even into the 60s, this person said. That didn't include what they owed in taxes, meaning that some borrowers could be left to live on 20 percent of their paychecks.
Mortgage lenders also extracted promises from Wall Street firms not to "kick out" as unacceptable more than 5 percent of the loans in a pool.
Goldman spokesman Michael DuVally denied that the firm felt pressure from mortgage lenders to relax its loan quality standards to win bids on pools of mortgages. He said that Goldman's standards were at least as tough in 2006 as they were in 2002, but he declined to describe them.
Goldman Sachs Mortgage, however, published guidelines in early 2007 indicating that it would accept a "stated income, stated asset" loan for a person with a subpar credit score of 600 who was borrowing 90 percent of his or her home's value. The designation meant that although the borrower had poor credit, his or her claimed income and financial background would go unchecked.
Deep in a Feb. 13, 2007, Goldman prospectus offering bonds backed by 9,800 New Century mortgages were these disclosures:
* 3,422 of the borrowers had credit scores below 600, levels that experts say could include applicants with past bankruptcies.
* 3,688 of the borrowers were required only to state their incomes, not to document them â mortgages that became known as "liars' loans."
* More than a quarter of the borrowers had combined first and second mortgage balances that equaled or exceeded 90 percent of their homes' values at the time.
As was typical, 34 percent of the loans in the 2007 deal were in California, and 9 percent were in Florida, markets where home prices were rising so fast that all the players shrugged off the risk that borrowers might default. If a loan soured, they thought, they could seize and easily resell the house without a loss.
[continued]
Why did blue-chip Goldman take a walk on subprime's wild side?
ABOUT THIS SERIES
A five-month McClatchy investigation reveals how Wall Street colossus Goldman Sachs peddled billions of dollars in shaky securities tied to subprime mortgages on unsuspecting pension funds, insurance companies and other investors when it concluded that the housing bubble would burst.
By Greg Gordon | McClatchy Newspapers
Goldman Sachs was one of the last Wall Street giants to enter the subprime lending world, but when it did, it quickly climbed into bed with profligate, highflying firms â companies such as New Century Financial Corp.
In at least nine deals from 2002 to 2007, Goldman sold bonds backed by more than $5 billion of New Century's mortgages, one even after the California lender's underwriting criteria all but disintegrated and a cash squeeze paralyzed its operation. Goldman also marketed at least three secret offshore deals bearing New Century's name.
By Greg Gordon | McClatchy Newspapers
IRVINE, Calif. â Goldman Sachs was one of the last Wall Street giants to enter the subprime lending world, but when it did, it quickly climbed into bed with profligate, highflying firms â companies such as New Century Financial Corp.
In at least nine deals from 2002 to 2007, Goldman sold bonds backed by more than $5 billion of New Century's mortgages, one even after the California lender's underwriting criteria all but disintegrated and a cash squeeze paralyzed its operation. Goldman also marketed at least three secret offshore deals bearing New Century's name.
Goldman has yet to explain why it risked its blue-chip reputation and financial health to buy and repackage at least $135 billion in loans mostly originated by companies that have since gone bust.
Goldman spokesman Michael DuVally stressed, however, that the firm "was not the largest purchaser of loans from any of these mortgage originators, and in some cases was actually quite a small purchaser."
A glimpse inside New Century's operations sheds light on how one of Wall Street's proudest and most prestigious firms helped create a market for junk mortgages, contributing to the economic morass that's cost millions of Americans their jobs and their homes.
Perhaps no mortgage lender was more emblematic of the go-go atmosphere in the sprouting industry that was seizing an outsize share of the home loan market.
Traversing the country in private jets and zipping around Southern California in Mercedes Benzes, Porsches and even a Lamborghini, New Century executives reveled as the firm's annual residential mortgage sales rocketed from $357 million in 1996 to nearly $60 billion a decade later.
To be a subprime lender at the industry's height was to join in a dash for cash, and New Century was an Olympic-caliber sprinter.
Its top five officers, who received nearly $40 million in salaries and bonuses from 2002 to 2005, could peer out the 10th-floor windows of their gleaming onyx headquarters in Irvine and see the offices of more than a dozen rivals.
"A friend of mine said you couldn't fire a .22-caliber rifle and not hit a subprime lender in Orange County," recalled a former manager of a company that reviewed subprime loan files before Goldman and other Wall Street firms bought the mortgages.
For $100 million in mortgages, New Century could command fees from Wall Street of $4 million to $11 million, ex-employees told McClatchy. The goal was to close loans fast, bundle them into pools and sell them to generate money for the next round.
Inside the mortgage company, the former employees said, pressure was intense to increase the firm's share of an exploding market for mortgages that depended almost entirely on Wall Street's seemingly unlimited hunger for bigger, faster returns.
Michael Missal, a federal bankruptcy examiner who investigated New Century's operations after it sought Chapter 11 protection on April 2, 2007, reported last year that the firm's lax lending and accounting standards "created a ticking time bomb" as it pushed for ever-higher loan production.
The incentives for high-risk behavior reached all the way to Manhattan.
Goldman and other investment banks could put $20 million in the till by taking a 1 percent fee for assembling, securitizing and selling a $2 billion pool of mostly triple-A rated bonds backed by subprime loans â and that was just stage one.
Goldman entities earned millions of dollars more by servicing many of the loans and arranging sophisticated interest-rate swaps to guard against inflation.
As profits poured in, Wall Street firms extended lines of credit to New Century â known as "warehouse loans" â totaling billions of dollars to finance the issuance of more home loans to other marginal borrowers. Goldman Sachs' mortgage subsidiary gave the firm a $450 million credit line.
As the economy slowed, the mortgage industry couldn't keep up with Wall Street's loan demands, but that actually generated leverage.
Kevin Cloyd, the New Century executive vice president who dealt with Wall Street and in 2006 also oversaw loan production, told examiner Missal that a tacit understanding developed with Wall Street firms that were trying to edge out each other for loans, said a person familiar with Missal's inquiry.
Cloyd revealed that investment banks willing to scale back their scrutiny of mortgage applications got to buy more loans, said this individual, who declined to be identified because the material is confidential.
Reached at his Los Angeles home, Cloyd declined to comment.
The former project manager who oversaw the review of tens of thousands of subprime mortgages for Goldman and other Wall Street firms said that in 2005 and 2006, subprime lenders gradually got investment banks to reduce the percentage of loans that were reviewed before deals closed.
"It went from 100 percent in the late '90s to probably less than 10 percent in 2006," said the ex-manager, who declined to be identified for fear that it would hurt his career.
By pitting firms such as Lehman Brothers, Bear Stearns, Credit Suisse and Goldman against each other for a shrinking supply of loans, mortgage bankers were able to sell loans in which borrowers' ratios of debt to income inched up to 50 percent, to 55 percent and even into the 60s, this person said. That didn't include what they owed in taxes, meaning that some borrowers could be left to live on 20 percent of their paychecks.
Mortgage lenders also extracted promises from Wall Street firms not to "kick out" as unacceptable more than 5 percent of the loans in a pool.
Goldman spokesman Michael DuVally denied that the firm felt pressure from mortgage lenders to relax its loan quality standards to win bids on pools of mortgages. He said that Goldman's standards were at least as tough in 2006 as they were in 2002, but he declined to describe them.
Goldman Sachs Mortgage, however, published guidelines in early 2007 indicating that it would accept a "stated income, stated asset" loan for a person with a subpar credit score of 600 who was borrowing 90 percent of his or her home's value. The designation meant that although the borrower had poor credit, his or her claimed income and financial background would go unchecked.
Deep in a Feb. 13, 2007, Goldman prospectus offering bonds backed by 9,800 New Century mortgages were these disclosures:
* 3,422 of the borrowers had credit scores below 600, levels that experts say could include applicants with past bankruptcies.
* 3,688 of the borrowers were required only to state their incomes, not to document them â mortgages that became known as "liars' loans."
* More than a quarter of the borrowers had combined first and second mortgage balances that equaled or exceeded 90 percent of their homes' values at the time.
As was typical, 34 percent of the loans in the 2007 deal were in California, and 9 percent were in Florida, markets where home prices were rising so fast that all the players shrugged off the risk that borrowers might default. If a loan soured, they thought, they could seize and easily resell the house without a loss.
[continued]