If there is anybody who should have avoided the mortgage catastrophe, it is me. As an economics reporter for The New York Times, I have been the paper's chief eyes and ears on the Federal Reserve for the past six years. I watched Alan Greenspan and his successor, Ben S. Bernanke, at close range. I wrote several early-warning stories in 2004 about the spike in go-go mortgages. Before that, I had a hand in covering the Asian financial crisis of 1997, the Russia meltdown in 1998, and the dot-com collapse in 2000. I had learned a lot about the curveballs that the economy can throw at us.
But in 2004, I joined millions of otherwise sane Americans in what we now know was a catastrophic binge on overpriced real estate and reckless mortgages. As I write in February 2009, I am four months past due on my mortgage and bracing for foreclosure proceedings to begin.
Nobody duped me, hypnotized me, or lulled me with drugs. Like so many others — borrowers, lenders, and the Wall Street deal makers behind them — I thought I could beat the odds. Everybody had a reason for getting in trouble. The brokers and deal makers were scoring huge commissions. The condo flippers were aiming for quick profits. The ordinary home buyers wanted to own their first houses, or bigger houses, or vacation houses. Some were greedy, some were desperate, and some were deceived. Maybe some were like me: in love.
Whatever our individual stories, the consequences of this nationwide bender are apparent. Wall Street's most iconic firms have been decimated, and the commercial banking system is effectively bankrupt. Bear Stearns and Lehman Brothers are gone. Merrill Lynch is the ravaged subsidiary of Bank of America, which itself is on life support from the federal government. Citigroup is a zombie bank. American International Group, once the nation's largest insurance company, is now an extremely expensive ward of the state.
Beyond the institutional wreckage, Americans are poorer than they were a few years ago. By the end of 2008, one out of eleven home mortgages was either delinquent or in foreclosure, according to the Mortgage Bankers Association. One out of every six homes was underwater, meaning that the mortgage amount was higher than the market value of the house. The number of families that had lost their homes to foreclosure had more than doubled since the housing bubble peaked, from just over 900,000 in 2006 to a new record of 2.2 million in 2008. As I write, analysts are predicting that at least 3 million homes will enter foreclosure in 2009 unless the government rescues them.
Between collapsing home prices and collapsing stock prices, the United States has lost about $12 trillion in wealth over the past two years. It is tempting to dismiss that figure as "paper losses," but it amounts to a gigantic hole in the nation's balance sheet that will take years to repair. Meanwhile, the United States has almost single-handedly tipped the rest of the global economy into its worst downturn in decades.
This book describes in gory detail how I got it wrong and the personal nightmare that followed, but its broader purpose is to explore how so many other people also went wrong. I know why I borrowed nearly a half-million dollars. The mystery is why so many people were so eager to lend it to me — not once, but three times. What were we thinking? How hard was it to understand the risks we were taking? Didn't we learn anything from the speculative bubble and bust of dot-com stocks in 2000?
I decided to explore that question by learning about the people who helped deliver the money to my door — the mortgage brokers and real estate appraisers, the lenders and the Wall Street securitizers, the credit rating agencies who blessed the deals, and the institutional investors who paid top dollar for a piece of the action.
I became an expert on the exotic new tools of home finance: a rainbow of "no-doc" and "low-doc" loans; interest-only loans; "piggyback" loans; and "option ARMS," known in various quarters as "pick-a-payment" loans and "exploding ARMS." As I began to drown in debt, I learned that I could borrow even more money and boost my credit rating in the process. Through it all, banks and finance companies happily competed to keep my shell game going.
Misery doesn't love company, but I do take some pride that I outlasted two of my three mortgage lenders. One of them, a highflier in the subprime business, was shut down by federal regulators in early 2007. Its loans were so bad that it became a catalyst for the panic that kicked off the broader financial crisis in August 2007. Another of my lenders became one of the most immediate victims of that crisis, collapsing overnight in the first week of August and becoming the second biggest bankruptcy of 2007.
The Great American Mortgage Bust wasn't a freak event, like a midsummer snowstorm. It was the result of a trend toward higher debt and greater speculation that had been building for at least twenty-five years. We were taught to borrow more, buy more, save less, and take bigger risks. We learned new financial tricks, grew more confident, and constantly pushed the limits of what seemed acceptable. "Creative financing," an early-1980s phrase that implied shady or stupid deals, was repackaged as "financial innovation." Debt became high-tech, sophisticated, even cool. When the borrowing binge reached its inevitable climax, the fallout engulfed a huge share of the country.
I am not a victim, because I knew full well I was taking a huge gamble. My hunch is that a large share of the people who are now in trouble knew in their gut they were taking unreasonable risks too. Adults who buy homes have to take responsibility for their decisions.
That said, this crisis would not have been possible without breathtaking cynicism on the part of the brainiest people and biggest institutions in American finance. For all the baffling complexities at work — "collateralized debt obligations," "conduits," and computer-run risk models — this is a fairly simple story about how a lot of really smart people embraced and proselytized for a lot of inexcusable hogwash.
"This crisis wasn't an accident. We didn't get unlucky," said David Einhorn, director of Greenlight Capital, a New York City hedge fund, in a speech in October 2007. "This crisis came because there have been a lot of bad practices and bad ideas. . . . Why should anyone be surprised? We got what we deserved." Amen. This was a democratic debacle that made fools out of people up and down the financial food chain. Yet it was worse than that. This was a debacle that stemmed from deep-seated rot and corroded ethics in our financial system.
When I first started digging into this crisis, I was struck by how dumb many of the players seemed. The more I learned, though, the more I became convinced that the blunders were too basic to be written off as boneheaded. Many of the people who should have known better did know better. Executives at one of Wall Street's biggest subprime factories, Merrill Lynch, ignored the prescient warnings of their own chief economist about the housing bubble. The rating agencies ignored blatant fallacies in their risk assumptions and compounded the problem by refusing to look at the actual mortgages behind the securities they were rating. Institutional investors went along with the rating agencies, despite a growing chorus of skeptics, because they wanted that extra kick of seemingly free yield that came from triple-A bonds backed by junk loans.
In Washington, of course, the Federal Reserve, the Bush administration, and Congress were ready to believe anything that business told them. When the true character of the crisis became apparent in 2007 and 2008, the Bush administration could not bring itself to believe that something was fundamentally wrong with the financial system or with the dogma of hands-off regulation. As late as December 2007, when the economy was tipping into a recession, President Bush was still confidently declaring that the fundamentals of the economy were sound.
My wife Patty and I may or may not hold on to our house. We most certainly will have to spend years making up the losses from our adventure. But if there is one conclusion I have reached from our experience, it is that our misjudgments, however egregious they were, pale in comparison with the self-enriching recklessness of those at the top of the financial ladder. They were the ones who behaved as if they had invented a perpetual-motion machine. They were the ones who rationalized the "see no evil, hear no evil" model of lending and risk management. For all the money that bankers and Wall Street executives have lost, they are still the ones who walked away from the disaster with tens or hundreds of millions of dollars more than they had at the start. In Washington, the level of malign neglect was every bit as unforgivable.
I have spent my entire adult life a believer in the merits of capitalism, free markets, and the pursuit of enlightened self-interest. I appreciate business and investing, in part because I like the creativity and willingness to take risks that go along with them. I admire entrepreneurs like Steve Jobs and Bill Gates, farsighted investors like Warren Buffett, and shrewd hedge fund managers like John Paulson and David Einhorn. All in all, I am still an economic conservative.
But this catastrophe has reminded us that free markets can become corrupt and self-destructive. Open competition is not always a self-correcting force, and the absence of regulation can be as lethal to capitalism as overregulation. American voters have already drawn the obvious lessons, throwing know-nothing Republicans out of the White House and reducing their ranks in Congress to a shrill but obstreperous minority. President Obama and Democratic lawmakers in Congress may well overshoot in trying to micromanage the economy, and they may well do so at the same time they capitulate to lobbyists from the financial industry. Let's face it: there is no simple balance between free-market dynamism and government oversight.
That is the polite, policy-wonk, New York Times side of me talking. On a personal level, I wish I could send one message to the millions of home buyers who made bad choices: don't beat yourself up over your mistakes.
Yes, you might have bought a house you knew in your gut you couldn't afford. Yes, you might have been a fool for not asking tougher questions about your mortgage — or even trying to read the mortgage. Maybe you were a shameless condo flipper who lied about your income on your "no-income-verification" loan, and maybe you've got the bill collectors after you now. From a moral standpoint, you may not deserve any kind of mercy or bailout from the government. I don't honestly think that I do.
Take a cue from the bank or Wall Street firm that is now trying to foreclose on your house. Don't apologize. They knew what they were getting into far better than you did. They knew they were in a giant Ponzi scheme, and they certainly should have known it would lead to disaster. They knew the housing bubble was a mirage. They knew their loans were absurd. They knew the triple-A ratings were bogus. They knew, they knew, they knew. They deserve whatever losses come their way.
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