The Center for Public Integrity

A little more than a decade ago, William Brennan foresaw the financial collapse of 2008.

As director of the Home Defense Program at the Atlanta Legal Aid Society, he watched as subprime lenders earned enormous profits making mortgages to people who clearly couldn’t afford them.

The loans were bad for borrowers — Brennan knew that. He also knew the loans were bad for the Wall Street investors buying up these shaky mortgages by the thousands. And he spoke up about his fears.

“I think this house of cards may tumble some day, and it will mean great losses for the investors who own stock in those companies,” he told members of the Senate Special Committee on Aging in 1998.

It turns out that Brennan didn’t know how right he was. Not only did those loans bankrupt investors, they nearly took down the entire global banking system.

Washington was warned as long as a decade ago by bank regulators, consumer advocates, and a handful of lawmakers that these high-cost loans represented a systemic risk to the economy, yet Congress, the White House, and the Federal Reserve all dithered while the subprime disaster spread. Long forgotten Congressional hearings and oversight reports, as well as interviews with former officials, reveal a troubling history of missed opportunities, thwarted regulations, and lack of oversight.

What’s more, most of the lending practices that led to the disaster are still entirely legal.

Growth of an Industry

Congress paved the way for the creation of the subprime lending industry in the 1980s with two obscure but significant banking laws, both sponsored by Fernand St. Germain, a fourteen-term Democratic representative from Rhode Island.

Just how did we get into this economic mess? The answers are both complex and troubling. Blame greed, irresponsibility, lax government oversight, conflicts of interest and especially blind faith in a housing boom that seemingly had no end. But end it did, setting off a chain reaction that has left the economy in tatters and stuck the American people with the tab.

Thus far, the government has committed $1.75 trillion to buying or propping up a portfolio dominated by devalued real estate assets — and this may be just a down payment. The Obama administration has a new plan that will commit more government cash to rid the financial system of the toxic assets that have wrecked the economy.

Roots in an Earlier Collapse

The origins of the current crisis can be found in an earlier calamity — the collapse of the technology industry in 2000. The Federal Reserve responded to that downturn by lowering interest rates. Ideally, lower rates trigger more borrowing and spending, which in turn lead to economic growth.

In May 2000, the Federal Reserve’s federal funds rate — the rate banks charge one another for overnight loans — was 6.5 percent. By August of 2001, it was 3.5 percent. The Fed further lowered rates after the attacks of September 11, to 1.75 percent by December. By June 2003, the rate had been cut to 1 percent and the average monthly rate on a 30-year, fixed mortgage, according to a Federal Home Mortgage Corp. (Freddie Mac) survey, dropped to 5.23 percent, the lowest level since the mortgage buyer started tracking rates in 1971. And so everyone, it seemed, was looking to buy a home.

There is something of a myth surrounding the current economic crisis, how it unfolded, and the precise role of the world’s largest financial institutions in the global meltdown. That myth suggests these banks and investment houses were somehow surprised “victims” of unscrupulous subprime mortgage lenders, and that they could not have anticipated the damaging toxic assets that have so infected their balance sheets.

What’s missing from this story is the fact that this was a self-inflicted wound for which the rest of us are picking up a massive tab. The largest American and European banks and investment houses were not the unwitting “victims” of an unforeseen financial collapse, as they have so often been portrayed. The mega-banks not only invested in subprime lending institutions — they were the enablers, bankrollers, and instigators driving high-interest lending, and they did so because it was so lucrative and unregulated.

Worse, in many instances these are the same financial institutions the government is now bailing out with tax revenues. How these bottomed-out banks helped cause the financial meltdown can be clearly seen in a new study by the Center for Public Integrity. The Center ran a computer analysis of every high-interest loan reported by the industry to the U.S. government from 2005 through 2007, a period that marks the peak and collapse of the subprime market. From this pool of 7.2 million loans, our investigators identified the top subprime lenders. The “Subprime 25” were responsible for nearly a trillion dollars of subprime lending, or 72 percent of all reported high interest loans.

The Center for Public Integrity began work on this project in fall 2008 as it became clear that subprime lending was at the heart of the financial crisis. While keeping track of other work in this investigative field, we believed that most news organizations were caught up in the rapidly changing day-to-day economic stories, and none were digging into precisely who was responsible for the subprime lending that contributed so heavily to the disaster.

In late September, the Center’s data editor David Donald began his computer analysis of some 350 million mortgage applications going back to 1994. We wanted to determine how America’s subprime lending unfolded and who the biggest lenders were. At the same time, reporter Kat Aaron began work on a widely overlooked history of attempts to reign in abusive loan practices, “Predatory Lending: A Decade of Warnings; Congress, Fed Fiddled As Subprime Crisis Spread.”

In January 2009, former Associated Press reporter John Dunbar, who had been covering the economic crisis in Washington, joined the Center and immediately began work designing a project around the top subprime lenders and their financial backers. Meanwhile, data expert Donald focused on the top loan originators from 2005 through 2007, a period that marks the peak and collapse of the subprime boom. These lenders we eventually dubbed “The Subprime 25.” With our data analysis in hand, Dunbar and a team of Center reporters put together profiles of all 25 top subprime lenders.

For its mortgage analysis, the Center used federal data collected under the Home Mortgage Disclosure Act (HMDA), enacted by Congress in 1975. The data included more than 350 million mortgage applications covering 1994 through 2007, the most recent year available. The loan-to-income analysis encompassed data from these years. The top 25 high-interest lender list is based on data for the years 2005 through 2007.

The act requires lenders to submit mortgage data to the Federal Financial Institutions Examination Council under rules devised by the Federal Reserve Board. While some small lenders are exempt, more than 8,500 lenders currently report details of the mortgage applications they receive, allowing researchers to track such items as the amount of money requested, the income of the borrower, whether the lender approved the loan, and what the loan was used for. Lenders report loans mostly originated in metropolitan areas, leaving out rural lending, and federal researchers estimate the data capture about 80 percent of all home mortgages. HMDA also requires collection of demographic information such as the race and sex of the borrower — data designed to track and expose discriminatory lending practices. The Center acquired its HMDA data from the National Institute for Computer-Assisted Reporting, a non-profit organization that supports the data needs of journalists.

The top subprime lenders whose loans are largely blamed for triggering the global economic meltdown were owned or bankrolled by banks now collecting billions of dollars in bailout money — including several that have paid huge fines to settle predatory lending charges.

These big institutions were not only unwitting victims of an unforeseen financial collapse, as they have sometimes portrayed themselves, but enablers that bankrolled the type of lending that has threatened the financial system.

These are among the findings of a Center for Public Integrity analysis of government data on nearly 7.2 million “high-interest” or subprime loans made from 2005 through 2007, a period that marks the peak and collapse of the subprime boom. The computer-assisted analysis also reveals the top 25 originators of high-interest loans, accounting for nearly $1 trillion, or about 72 percent of such loans made during that period.

The Center found that U.S. and European investment banks invested enormous sums in subprime lending due to unceasing demand for high-yield, high-risk bonds backed by home mortgages. The banks made huge profits while their executives collected handsome bonuses until the bottom fell out of the real estate market.

Investment banks Lehman Brothers, Merrill Lynch, JPMorgan & Co., and Citigroup Inc. both owned and financed subprime lenders. Others, like RBS Greenwich Capital Investments Corp. (part of the Royal Bank of Scotland), Swiss bank Credit Suisse First Boston, and Goldman Sachs & Co., were major financial backers of subprime lenders.

According to the Center’s analysis: