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'If you had a pulse, we gave you a loan'

By the end of 2008, a record 5.4 million homeowners were delinquent on their mortgages or in foreclosure. Over the course of six months, Dateline NBC spoke to Countrywide insiders about the unethical practices that led to their institution's collapse, and whistleblowers who explained how the U.S. got into the mortgage mess.
/ Source: Dateline NBC

In Miami, Fla. last fall, sheriff’s deputies showed up at Junior Alvarez’s house to evict him and his family. That was just one of 3.2 million foreclosure-related actions last year.  “We tried to save the house,” a shaken Alvarez said, “but it was too much.”

“Too much” is a phrase being uttered by Americans in all walks of life these days. A six-month Dateline NBC examination of the origins of the economic crisis found plenty of blame to go around, and few people willing to step up and acknowledge their culpability. 

Since taking office, President Barack Obama has been stressing the need for accountability, not simply to “lay blame,” as he put in his speech before both houses of Congress in February. “It is only by understanding how we arrived at this moment that we’ll be able to lift ourselves out of this predicament,” he said.

Understanding how we got here is simultaneously simple and complex. Simple, in that the root causes can be traced to excesses in the multi-trillion-dollar mortgage industry.  Complex, because the greed that permeated the industry was driven by some of the most arcane financial instruments ever devised by Wall Street. Those instruments, mainly derivatives of mortgage-backed securities, became so convoluted that instead of lowering financial risk, as they ostensibly were intended to do, they actually expanded and obscured it.

In the old days, a mortgage was relatively straightforward. A bank agreed to lend you money to buy a house, and the property was collateral for the loan. Banks were conservative in their lending because they expected to be paid back with interest.

In order to qualify for a mortgage, until 1956, borrowers needed a 20 percent down payment. From the 1920s to the 1950s, the rate of home ownership in the U.S. hovered around 50 percent.

But then came a succession of laws that eased lending and eventually expanded home ownership dramatically. Among the key changes: Fannie Mae, created in the 1930s, was transformed in 1968 into a government-guaranteed agency buying mortgages from lenders and providing an enormous supply of funds.  It was joined in 1973 by a similar agency, Freddie Mac.

The advent of the CDO
But some say the real fuel for the boom in home ownership came from Wall Street, which found innovative ways to invest in mortgages. In the 1980s, investment banks began marketing mortgage-backed securities, bonds built from thousands of loans bundled into one instrument that paid interest to investors. The money raised from selling those bonds added to the flow of funds to mortgage lenders, who in turn were able to make more loans.

Then, Wall Street came up with a new type of security called a collateralized debt obligation (CDO), which pooled the risks from mortgage-backed securities and other debt. The little-regulated securities brought hundreds of billions of dollars more into the system.

It was that infusion of money, plus provisions of the Community Reinvestment Act, passed in 1977 and amended in the 1990s, that ignited the housing boom. By 2004, home ownership reached nearly 70 percent. As Sen. Chris Dodd D-Conn., commented before his colleagues, “in no small measure… because of the work that's been done here.”

But the system became so lax that nearly anyone could qualify for a loan. And it reached the point where lenders did not ask for a down payment at all.  They were willing to lend 100 percent of the purchase price, usually split into two loans: one for 80 percent of the value; the second for 20 percent.

Take the case of Paula Taylor, a personal trainer, who said she grew up poor near Boston and was one of the first in her family able to buy her own home.  In 2006, she said she was virtually homeless, living out of a suitcase, sleeping on the sofas of family members and friends.

She was looking to rent an apartment, but then a realtor showed her a condominium for sale in a renovated house in Roxbury, Mass. 

She was put in touch with a loan officer at Countrywide Financial who took her information.  She knew she might have a hard time qualifying, but said she did not really understand a lot about the mortgage process.  “I knew that you give them your information.  And they run the numbers, and they tell you whether or not you can afford it.”

At the time, her income was somewhat erratic and amounted to less than $20,000 a year, she said.  But somehow her loan application listed her income as $7,300 a month – $87,600 a year, more than four times her real income. 

Countrywide issued her two mortgages to cover the full purchase price: $259,900. The first mortgage was for $194,925 with an initial interest rate of 8.625 percent, fixed for two years, then adjustable.  The second mortgage, in the amount of $64,975, had a much higher interest rate: 11 percent. 

The combined monthly payment for both loans was more than $2,100, well above her average monthly income of $1,600.

Pointing the finger
Pressed as to how the loan application could include inaccurate and inflated income information, Taylor acknowledged she didn’t really look closely at the loan documents and said she never noticed the amount until NBC News pointed it out to her.  She denied knowingly submitting false information and pointed the finger at Countrywide: “It had to be them in order to finagle the numbers to say that I could afford this property.”

What she may not have realized is that she was issued so-called stated income loans, where the lender did not verify actual income.  Borrowers liked them because they made it much easier to qualify, and lenders loved them because they could charge higher interest.

As a result, stated income mortgages became extremely popular during the height of the boom. In 2006, for instance, the year Taylor got her loans, subprime lenders issued an estimated $265 billion in stated income mortgages, according to data supplied by First American CoreLogic and the trade publication Inside Mortgage Finance.

To highlight just how simple it could be to borrow money, Countrywide marketed one of its stated-income products as the "Fast and Easy loan." 

As manager of Countrywide’s office in Alaska, Kourosh Partow pushed Fast and Easy loans and became one of the company’s top producers.

He said the loans were “an invitation to lie” because there was so little scrutiny of lenders.  “We told them the income that you are giving us will not be verified.  The asset that you are stating will not be verified.” 

He said they joked about it: “If you had a pulse, we gave you a loan.  If you fog the mirror, give you a loan.”

But it turned out to be no laughing matter for Partow. Countrywide fired him for processing so-called “liar loans” and federal prosecutors charged him with crimes. On April 20, 2007, he pleaded guilty to two counts of wire fraud involving loans to a real estate speculator; he spent 18 months in prison.

In an interview shortly after he completed his sentence, Partow said that the practice of pushing through loans with false information was common and was known by top company officials.  “It’s impossible they didn’t know.”

A rogue manager?
During the criminal proceedings in federal court, Countrywide executives portrayed Partow as a rogue who violated company standards.

But former senior account executive Bob Feinberg, who was with the company for 12 years, said the problem was not isolated.  “I don’t buy the rogue.  I think it was infested.”

He lamented the decline of what he saw as a great place to work, suggesting a push to be number one in the business led Countrywide astray.  He blamed Angelo Mozilo, a man he long admired, for taking the company down the wrong path.  It was not just the matter of stated income loans, said Feinberg.  Countrywide also became a purveyor of loans that many consumer experts contend were a bad deal for borrowers, with low introductory interest rates that later could skyrocket.

In many instances, Feinberg said, that meant borrowers were getting loans that were “guaranteed to fail.”

Paula Taylor’s primary loan was set to adjust in two years. 

She claimed the loan officer told her not to worry, that if she made her mortgage payments on time for a year or so, she would be able to refinance at a better rate.

She knew she could not really afford the place on her own, she said.  She invited her sister to move and pay rent.  But Taylor’s sister did not stay long.

Taylor defaulted in only seven months. 

In retrospect, she was willing to blame herself “a little bit,” but put most of the onus on Countrywide. “Why would they tell me as the lender that I can afford this,” she asked,  “if they know they're not going to get their money back?”

With foreclosure rates at an all-time high, it is a reasonable question.  Equally reasonable is why so many borrowers did not heed common sense and pay closer attention to the terms and conditions of their loans.

In Michigan, Linda Johnson acknowledges with regret that she failed to read her mortgage papers. A retired school principal, she lived in the same comfortable brick home for 26 years.  When her daughter was accepted at an Ivy League college, Johnson decided to refinance and take out cash from the new, bigger mortgage to help pay tuition.

She thought she was getting a fixed rate mortgage, she said, but because she did not look closely at her loan papers, she did not realize her interest rate was going to climb to nearly 12 percent. When the rate adjusted, she had a hard time keeping up with payments and ended up borrowing money from her pension fund.  “I’m tapped,” she said.

She was recently able to work out a deal with her lender for a lower interest rate.

David Carbajal was not as fortunate. A gardener in Orange County, Calif., Carbajal had taken on a $600,000 mortgage, with payments adding up to more than $60,000 a year, substantially more than the $50,000 a year he said he earns.  He had no real explanation as to why he never did the math to figure out that the house was beyond his means, though he was able to afford for a time because he rented a room to a friend.  Not surprisingly, Carbajal ended up in foreclosure.  Recently, he and his family were forced to move out.

But his story pales in comparison to that of Delores Parker-Jackson, a 61-year-old widow living in Los Angeles. In an interview, she said she made a good living running a day care service and raising foster children.

She said her income – ranging between $144,000 and $300,000 a year – enabled her to acquire four condominiums in a gated complex in West Los Angeles, one where she lived and three others with family members and rent-paying tenants.

By 2006, she held at least six mortgages on the condominiums from four lenders totaling more than  $1.3 million. In at least three cases, she refinanced existing mortgages for larger amounts and took out more than $200,000 in cash in all.

To cover the full $499,000 purchase price of the duplex where she now lives, she obtained two loans that were funded through a mortgage broker by WMC, a company at the time owned by NBC Universal parent General Electric.  (GE sold WMC in 2007.)  Those loans were serviced by Countrywide. ( is a joint venture between Microsoft and NBC Universal.)

Two mortgages totaling $296,000 were issued by a subprime lender called People’s Choice Home Loan on another of her condominiums across the street. 

But a review of public records raises questions about whether Parker-Jackson was truthful about her income and financial solvency on her loan applications. 

In the late 1990s, she and her husband filed for bankruptcy several times. The cases were all dismissed. In 1997, the family was evicted from a house in Beverly Hills for non-payment of rent.  The landlord eventually obtained a judgment against the couple, which they failed to pay. Her husband, Tyrone Jackson, died in 2003.

By 2007, Parker-Jackson was behind on many of her mortgage payments.  At the same time, the man with the outstanding judgment filed a legal claim to have it enforced.  Parker-Jackson filed for bankruptcy protection yet again.

After the Chapter 11 case was dismissed, Parker-Jackson filed for Chapter 13.  During bankruptcy court proceedings, she said she had suffered substantial losses in 2005 and 2006 because she did not bring in enough rental income to cover her costs. She also acknowledged she did not have any actual leases signed by tenants.

A copy of her 2006 IRS tax form 1040 reports a negative gross adjusted income of -$6,813.

‘I’m a victim’
In an interview, she acknowledged falling behind on her mortgage payments.  She seemed confused about her income and blamed her problems on lenders and an unjust legal system that are trying to expropriate her.  “I don’t think I got in over my head,” she said.  “I’m a victim.”

Lenders and the Los Angeles sheriff’s office have been stayed from taking her properties while bankruptcy proceedings are pending, but Parker-Jackson has just about exhausted her options in bankruptcy court and is facing the prospect of eviction all over again.

Basic due diligence by lenders might have uncovered some of the discrepancies in Delores Parker-Jackson’s case. 

But how much checking did lenders do? At People’s Choice Home Loan, for instance, Parker-Jackson obtained stated income loans.  So, by policy, underwriters would not have bothered to verify that she really made the $15,500 a month she claimed.

Through a spokesman, People’s Choice CEO Neil Kornswiet told Dateline NBC his company was “one of the most conservative subprime lenders on the industry.”  He pointed out that People’s Choice did not issue some of the more notorious loan products, like the payment option ARMs sold by Countrywide, in which borrowers could choose to pay less than the standard monthly charge; with the unpaid amount then added to the principal due.

“Less than 40 percent” of People’s Choice loans were stated income, Kornswiet’s spokesman said, claiming that amount was lower than the industry average.  According to First American CoreLogic, a firm that collects such data, on average, what it calls “low documentation/no documentation loans” represented 40 percent of all subprime loans issued from 2004 to 2007.

Kornswiet’s spokesman also said that People’s Choice underwriters did verify that borrowers worked in the jobs they put on their loan applications and checked to make sure the amount of income claimed was reasonable for the occupation listed.

During the peak, in 2004 and 2005, People’s Choice originated more than $5 billion in mortgages a year, including an estimated $2 billion a year in stated income loans. (Ameriquest, the biggest subprime lender, originated more than $70 billion in mortgages during the same period.) 

But a look at some of those stated income loans is instructive. 

James LaLiberte joined People’s Choice in 2004 as the chief credit officer, overseeing the underwriting. Later, he was promoted to one of the top positions, chief operating officer, and was in charge of all operations and setting credit guidelines.

He presented Dateline with a list of nearly 13,000 loans People’s Choice funded in one year from April 2004 through March 2005, totaling more than $2 billion.  Many of the loans, he said, were questionable; some possibly fraudulent.

In an interview, he said that when he came on board, the company’s reputation was “spotty at best,” though he acknowledged the company was more conservative than many other subprime lenders.  

He said he welcomed the opportunity to help raise standards and credited CEO Kornswiet with trying to improve the company.  In the 1990s, he had worked as Kornswiet’s top underwriter at a company called One Stop mortgage, one of several management positions LaLiberte held during more than a decade in the mortgage business.  Before entering the subprime world, LaLiberte spent seven years at traditional lender Wells Fargo. 

Income discrepancies
Dateline independently researched dozens of the stated income loans on the list LaLiberte presented and found many instances where incomes apparently were inflated.

Examples on the People’s Choice list included a registered massage therapist who claimed an income of $15,000 a month ($180,000 a year) and whom People’s Choice loaned $640,000.  According to the Web site, which is often used by lenders, the median income in the zip code where the borrower lived is $3,799 a month, about one quarter of the amount the borrower claimed. 

A manicurist who borrowed $445,500 in 2004 claimed monthly income of $16,800, more than $200,000 a year. Later, she filed for bankruptcy and submitted papers to the court reporting her 2005 annual income as $27,092, meaning  $2,258 a month (plus approximately $4,500 a year in child support). 

Another borrower in 2005 listed herself as director of development for a charity earning $15,500 a month ($186,000 a year) and obtained $655,000.  But a review of the charity’s publicly-filed tax returns shows that the director of development that year was paid $69,808, or $5,817 a month. Surprisingly, that person has a different name from the borrower.  A call to the charity elicited the information that the borrower indeed had worked there at the time the loan was issued, but held a position below director of development.

Former People’s Choice COO LaLiberte said that he used the list of loans as a training tool.  He put the spreadsheet up on a screen to highlight the types of loans the company should stop issuing. 

“The initial reaction was laughter,” LaLiberte said. “And then I said, ‘Well, wait a minute here.  Y’all think it's funny.  I think it's funny, too, sort of.  But these are loans that we funded. These are loans that we wired the money on.’"

He said that when he tried to implement more controls, he ran into resistance.  “The chief appraiser once said, ‘Fraud is what we do.’ That’s how we got where we are today.’”  Another former executive told Dateline he was present when the comment was made and confirmed the accuracy of LaLiberte’s account.

Neil Kornswiet’s spokesman said that Kornswiet’s lawyer spoke with both chief appraisers from the time LaLiberte worked at the company and both denied ever making such a statement. 

As for bad loans getting through, the spokesman said that “LaLiberte was the primary architect of the system.  He was in charge of the underwriting guidelines…. It was his responsibility to make certain these issues were addressed and did not happen.”

Eileen Loiacono was an underwriter at People’s Choice from 2003 until September 2005. She said LaLiberte tried to do the right thing, but lost out to more powerful forces. 

She and several other underwriters told Dateline that they felt pressured by sales staff to approve questionable applications. While their work as underwriters was supervised by a chief credit officer, they said that for administrative and basic personnel matters, they reported to sales managers.

One former People’s Choice manager who spoke on condition of anonymity said, “That place was run by the sales people,” some making $200,000 to $300,000 a month.  That did create pressure on underwriters, the former manager said. “There was a lot of ‘keep your mouth shut’ going on, meaning you just didn’t ask questions about things you knew were wrong.”

Loiacono said that the problems and pressure were not restricted to stated income loans, but also involved full documentation applications for which borrowers submitted records to prove how much they made.

Falsified documents
She said she saw numerous instances of falsified W-2s, tax returns, and bank statements, including crude cut-and-paste jobs. “They would use someone else's tax returns, and then they'd put someone else's name in them,” she said.

She said that she challenged about a third of all loan applications but was overruled by company executives the vast majority of the time.

According to Loiacono and several other underwriters, in a few instances, sales people offered incentives to sign off on loans.  Loaicono claimed the offers included breast implants, cars, and cash.  She said she declined all such offers and reported them to the human resources department.  She said nothing was done, as far as she knows.

Loiacono said that some sales people engaged in intimidation, threatening, for instance, to slash the tires of an uncooperative underwriter. Another underwriter, who requested anonymity, told Dateline her car was scratched up with a key by a sales person she crossed. 

The environment became too uncomfortable, Loiacono said, so she quit in September 2005.  “I wanted to be able to sleep at night without feeling like I was coming into a fight every day about something that I knew needed to be done right, and was not being done right.”

Neil Kornswiet’s spokesman said they could find no record of Eileen Loiacono reporting allegations of attempted bribery. In a statement, he said: “Any effort to bribe underwriters, or for them to accept bribes or benefits for violating company rues, was clearly and absolutely against company policy. While it is possible that a few instances of violation of company policy escaped these tight controls, this type of activity was strictly contrary to the culture and the standards of the company to which its many good employees adhered.”

He also said that People’s Choice fired approximately 30 employees for violating company policies and cut off business ties with more than a hundred unethical mortgage brokers.

In addition, the spokesman provided Dateline with statements from five former People’s Choice underwriters, all saying that they did not know of any cases where underwriters had been offered or accepted bribes and that anyone caught engaging in such practices would have been fired.

Kornswiet’s spokesman acknowledged that it is possible that “People’s Choice was an occasional victim of fraud” and that some bad loans may have “slipped through.”  But, he said, those would represent the vast minority of cases.  He said that the company did more to verify stated income loan applications than most other subprime lenders. 

In 2005, Neil Kornswiet was planning to take the company public. As part of the process, the company hired auditors from Deloitte to conduct a so-called Ethical Climate Survey.

On a positive note, the survey found the 96 percent of employees said they are expected to comply with laws and policies.  Ninety-one percent said their supervisors behaved ethically.

But, on the whole, the findings were devastating. Nearly three quarters of respondents said they were expected to do what they were told “no matter what.”  Nearly half said that while they may care about ethics, “they act differently.”  One third said they had witnessed “breaches of applicable laws and regulations.” And ten percent said they had been asked “to do fraudulent things.”

“It was double digits.  And it was very disturbing to executive management,” said former COO LaLiberte.  “You look at that and you think to yourself, ‘How am I going to correct something that's this far out of control?’"

Through his spokesman, Neil Kornsweit conceded that “management and the Board were dismayed by what they read.” After reviewing the survey, he said the company took steps “to address the comments that were contrary to the company’s standards.”  They set up a whistleblower hotline and provided mandatory ethics training to employees. Kornswiet also held a town meeting, the spokesman said, telling employees: “We will not be satisfied until we reach 100 percent compliance with all ethical standards.”

'Wall Street was the end of the line'
Ethical problems were endemic throughout the industry, and arguably far worse at lenders like Ameriquest and Countrywide, both of which ended up paying huge settlements after they were accused of predatory lending (though neither admitted wrongdoing). The driving force was greed, not just among loan officers, but more significantly on Wall Street, where firms like Bear Stearns and Lehman Brothers were making a fortune buying up mortgages and bundling them into securities.

“Wall Street was the end of the line,” said Paul Muolo, Washington editor of the National Mortgage News and co-author of the book Chain of Blame.  “That's where the rubber met the road.”

Investment banks paid lenders a premium for subprime loans, often around 105 percent of the value. Securitization became so lucrative, many lenders began to issue their own mortgage-backed securities.

In fact, Parker-Jackson’s primary mortgage from People’s Choice was combined with nearly 6,000 others issued by the lender into a mortgage-backed security, People’s Choice Home Loan Securities Trust Series 2005-2, which was then sold as an investment on Wall Street.

Similarly, Countrywide combined Paula Taylor’s mortgage with more than 6,000 others in a security called CWABS 2006-13.

Bonds like those generated premiums for the lenders and fees for the investment banks administering them. Then, investment banks created more trusts, CDOs, which bought up portions of the mortgage-backed securities and repackaged them in enormous pools of debt.

Portions of the People’s Choice bond into which Parker-Jackson’s loan was bundled were sold and folded into at least 20 different CDOs.  Portions of the Countrywide bond that contained Paula Taylor’s were purchased by at least 34 different CDOs. 

The investment banks behind the CDOs then marketed them to institutional investors.  At each turn, they were collecting fees.

“They made money in all sorts of ways,” said Muolo. “It was a beautiful thing for Wall Street.  They ran a bond factory. They just wanted to buy those loans and make bonds as fast as they could.”

From 2004 through 2006, according to Inside Mortgage Finance MBS Database, more than $6 trillion in mortgage-backed securities were issued, slightly more than half in the private sector, with the remainder issued by government-backed entities like Fannie Mae and Freddie Mac.

Those trillions of dollars were helping fund the housing boom, which was spinning out of control.  Muolo recalled sitting out on a Sunday afternoon with friends sipping cocktails.  “We'd see the house across the street sell for 25 percent more than it did three months earlier, and we'd say, ‘You know, who the heck is buying these houses?’”

All too often, the people buying those houses were borrowers taking out subprime loans.

As home prices were soaring, Muolo said, Wall Street ignored the true risk of the loans they were buying and packaging.  “It looked like it was going to be limitless for Wall Street. They thought it was going to go on forever and ever.”

He said the investment banks had plenty of opportunities to figure it out. In some instances, the firms themselves did due diligence reviews of the loans being securitized.  In others, they hired outside consultants to do the job.

After Eileen Loiacono quit working at People’s Choice, she was hired by a consulting firm to review loans for major Wall Street firms like Lehman Brothers and Bear Stearns.

Frequently, she said the due diligence staff would set up shop in a local hotel conference room with long tables and stacks of documents.  She said the pressure was on to get through loans as fast as possible.

“They're crackin' the whip,” Loiacono said.  “And they don't want you to question anything.” 

She said that hampered her ability to examine loans for signs of undue risk or fraud.  When she pointed out red flags, she said, she was sent to the human resources department and reprimanded.

Even when she pointed out obvious fraud, she said, there were instances when representatives of the investment banks took the loans anyway.  “It took the wind out of my sail,” said Loiacono.

When she saw so many bad loans making their way through the financial system, she said, she realized there were going to be serious ramifications for the financial system.

Information withheld
Her concern was echoed by former People’s Choice COO LaLiberte, particularly with regard to disclosures made to Wall Street investors buying loans from People’s Choice.  LaLiberte said he believed his company withheld pertinent information from Wall Street about the true risks of some loans.  

He said that there were two ways in which this happened.  First, he said, some loan files were “scrubbed,” meaning documents with potentially conflicting information were removed.  Sometimes, he said, the information removed was innocuous. Other times, however, he said information that might reflect a lower income was removed. Secondly, he said, sometimes after a loan was sold, the lender would get information such as income tax records (which borrowers authorize lenders to obtain when applying for a loan) that showed a borrower had overstated income on the loan application. 

LaLiberte said he went to see the company’s general counsel about the issue. “I inquired as to what our obligation was to notify investors of defective loans and/or repurchase them. He indicated he believe we did have an obligation to notify, and allow the investor to make the decision to repurchase the loan.”

LaLiberte said that, as far as he is aware, People’s Choice did not share such information with investors.  Another former manager agreed with him.

But the former director of Investor Relations for People’s Choice, John P. Salvador denied LaLiberte’s assertions.  “It was the policy and practice of the company to make certain that everyone knew that no documents could be removed from a loan file,” he said.  Investors, he added, “were always given everything they asked for.”

Through his spokesman, former CEO Kornswiet called LaLiberte’s statement “flat out untrue…. People’s Choice DID make full disclosures” and gave investors full access to both physical loan files and electronic data “to do whatever level of due diligence they wanted with the [sic] all of the facts in front of them.” 

He said that the company had to repurchase bad loans from Wall Street, so it had no incentive to push them through. He also said that investments profited far more than People’s Choice, claiming that on $5 billion in loans, People’s Choice made profits of “less than $13 million” while investment banks made $150 million or more off repackaging and reselling the same loans.

Even if lenders and investment banks were not doing an effective job weeding out bad loans, there was another actor in the system that might have been able to figure out the true risk: ratings agencies like Moody’s, Fitch, and Standard and Poor’s.

Over the years, the ratings agencies had developed sophisticated systems to analyze the risk of mortgage-backed securities.  According to Richard Gugliada, a former managing director of Standard and Poor’s, those securities had proven extremely reliable.  “The historical experience of mortgage-backed securities was, plain and simple, these securities do not default,” Gugliada said in an interview.  “They were very solid investments.”

He said that his company did the best job possible with the information it had at the time. He added that when Wall Street invented CDOs, which are super complex in comparison with regular mortgage-backed securities, his firm adapted accordingly, developing even more sophisticated models to assess the risk.

“We had two guys who came out of NASA,” he said, “NASA scientists.”

Some critics, including members of Congress who held a hearing on the issue, have accused ratings agencies of disregarding risks to please their customers: namely, the investment banks that paid Standard and Poor’s to rate their securities.

Gugliada acknowledges that approximately 90 percent of the time, his group at Standard and Poor’s rated CDOs AAA, the highest rating possible.  But Gugliada denied there was any impropriety.  “Nobody was giving away ratings,” he said.  “Every single deal that went out the door had to meet our criteria standards.”

In retrospect, he said, he would not have given any CDOs tied to mortgages a AAA rating. But he is adamant that it is not the fault of the experts.  “It's not the rocket scientists who were to blame.  It was the lack of data to support some of the assumptions that were being made.”

For financial writer Paul Muolo, that defense is weak. “I don't care if you're from NASA or Vassar,” said Muolo. “There was no history at all of a market where you were lending money to people with bad credit to buy a house and you were accepting downpayments that were zero.”

But with AAA ratings, many CDOs ostensibly were solid and, at the same time, paid a high rate of return. Those were strong marketing points for the investment banks selling them.  “Wall Street has got this reputation for being the smartest guys in the room,” Muolo said.  “When someone from a reputable Wall Street firm calls you up and says they have a great investment, you tend to believe them.”

CDOs were not for the small investor. Pension funds bought in. So did some municipalities like Springfield, Massachusetts.  Many CDO investors were overseas in Europe, Asia, and Australia.  Some of the biggest investors were investment banks themselves.

But, by 2005, some experts on Wall Street began to have their doubts about the market in mortgage-based investments.  At Deutsche Bank, which was a major player in the mortgage investment business and backed some CDOs, top analyst Karen Weaver realized there might be serious trouble ahead.

In April 2005, she took a group of investors to visit lenders in California. “It was the first peek behind the green curtain, if you will, sort of-- to-- how these mortgages were being underwritten,” Weaver said in an interview.

She said she was stunned by some of the reasoning she heard, especially concerning risky subprime loans.  Lenders did not see them as long-term investments, but more as short-term bridge financing, she said.  “What was disconcerting was it meant that they weren't really vouching for the fact that they were creating a loan that they felt was credit-worthy.” 

She said she discovered that lenders were encouraging borrowers to plan to refinance adjustable mortgages within two years or so. In other words, before borrowers defaulted, the underwriters reasoned, they could pay off their risky loans with yet other risky loans. “They were saying that essentially the problems could roll off down the line,” Weaver said.

She believed lenders were just putting off the inevitable day of reckoning. While she foresaw major trouble ahead, she said she did not know how bad it would get.

In September 2005, her group at Deutsche Bank issued a report predicting that "subprime mortgage losses will increase significantly" and recommending that investors bet against the mortgage market.

While Weaver is credited with being among the first to sound a warning, Harvard Law School professor Elizabeth Warren, who specializes in consumer finance and bankruptcy, believes that many on Wall Street must of have had an inkling of the trouble looming.  “I'm sorry, the only people who can say we never knew are people who didn't want to know,”  Warren said in an interview. 

Warren, who is now chairing a Congressional panel overseeing the massive federal bailout, said that the system was bound to blow up, “because it was based on a scam.”  She added, “This is about buying toasters that, at the moment they were sold, the person selling them knew these things are going to explode.”  She had harsh words for lenders, accusing them of selling “mortgages to people who simply weren’t going to be able to pay them off.”

The beginning of the end came in 2007, when borrowers like Paula Taylor found themselves unable to meet the mortgage payments.  A community group in Boston tried to help Taylor stave off eviction, but failed.  Taylor, who said she is still embarrassed about what happened to her, lost her condominium.

The bad loans start surfacing
Across the nation, borrowers defaulted in droves.  As the bad loans surfaced, it set off a kind of nuclear chain reaction.  When the loans went bad, so did many of the securities created from them and the CDOs built off of those mortgage-backed securities.

Consider what happened to the investments derived from securities that held Taylor’s Countrywide mortgage and Delores Parker-Jackson’s with People’s Choice Home Loan.  Out of the 54 different CDOs that purchased portions of those mortgage-backed securities, 21 have defaulted; many others are worth a fraction of their original value.

Compounding the problem, many of those securities were hedged by insurance policies called credit default swaps, which were peddled heavily by the now-notorious insurance group, AIG.

When it all blew up, stalwarts of Wall Street like Bear Stearns and Lehman Brothers collapsed.  The mortgage business dried up. Ameriquest closed up shop. Countrywide was bought up by Bank of America. (A spokesman for Bank of America said the company is looking into how Paula Taylor got her loan.)

The much smaller People’s Choice Home Loan filed for bankruptcy.

Now, everyone is trying to figure out whom to hold accountable.

Given the number of mortgage applications possibly processed with false information, technically hundreds of thousands of borrowers, loan officers, and underwriters could be considered liable. 

Kourosh Partow, the former Countrywide manager who went to prison for processing “liar loans” put it in perspective.  “You know, and if you ask a loan officer, he's going to probably say, ‘I blame myself a little bit because the underwriter was supposed to catch any mistake in the file.’ And all the way down to Wall Street and so on.  Everybody blames themselves a little bit.  Meanwhile, we have a major problem in this country.”

Should they all go to prison, as Partow did?

“That's a question that you have to ask America,” said the Iranian-born Partow. “I think there's going to be a very, very, very high percentage of those loans with the information will not be matching their tax returns.” 

Last week, FBI Deputy Director John Pistole told the House Committee on Financial Services that the Bureau currently has approximately 2,000 open investigations into mortgage fraud, up dramatically from 881 in 2006.  In addition, Pistole said, there are 566 corporate fraud investigations underway, including at least 43 into “matters directly related to the current financial crisis.”

For Harvard professor Elizabeth Warren, it is the people at the top of the chain — like former Lehman CEO Richard Fuld, former Bear Stearns chief James Cayne, and Countrywide founder Angelo Mozilo — who deserve the most scrutiny.

“They didn't get it wrong from their point of view,” said Warren.  “They made big money.  Go back and look at the compensation.”

According to Forbes magazine, Cayne took home $155 million in his last five years on the job; Fuld $354 million; and Mozilo nearly $400 million.

Once upon a time, these financial powerhouses were happy to speak their mind. Now they tend to keep a very low profile. Mozilo has not been heard from in months. Fuld did speak up when he was called to testify at a Congressional hearing chaired by Rep. Henry Waxman last fall.  “Given the opportunity to look back, I would have done things differently,” Fuld said.

Elizabeth Warren said the toughest question she would ask the fallen CEOs is: “So what do you plan to do now?  Here we are, you're rich.  But what are the rest of us going to do?”

That is what a lot of people are wondering, including many interviewed for this report, who have lost jobs or homes or both.

James LaLiberte, the former chief operating officer of People’s Choice Home Loan said he is looking for work.  Meanwhile, he is living off the proceeds of a home he sold before the bubble burst. 

His former boss, CEO Neil Kornswiet is a consultant to a company called Value Home Auctions, which is auctioning foreclosed properties.  He lives in a multi-million dollar home overlooking the Pacific Ocean and owns a private plane. Like many others who got tangled up in the subprime mess, he may also be facing litigation. According to a letter filed by lawyers for People’s Choice unsecured creditors, Kornswiet is facing several potential legal claims, including one that he improperly withdrew more than $13 million of deferred compensation from a company trust.

Kornswiet’s spokesman said that the allegations are “untrue” and that Kornswiet was entitled to withdraw the money.  “The documentation is entirely clear on this.”

As the battles mount over settling scores, the public is trying to sort out how to get out of this mess in one piece.

The average American family is crashed and burned, according to Elizabeth Warren.  “Families are wiped out over this,” she said.  “We're bankrupting people who worked their whole economic lives.  And we're saying, 'Hey, you know, this is how markets work.'”