AMERICAN PREDATORY LENDING AND THE
GLOBAL FINANCIAL CRISIS
ORAL HISTORY PROJECT
Interview with
Paul Stock
Bass Connections
Duke University
2020
PREFACE
The following Oral History is the result of a recorded interview
with Paul Stock conducted by Callie Naughton on February 24, 2020. This
interview is part of the Bass Connections American Predatory Lending and the
Global Financial Crisis Project.
Readers
are asked to bear in mind that they are reading a transcript of spoken word,
rather than written prose. The transcript has been reviewed and approved by the
interviewee.
Transcriber: Kate Karstens Session: 1
Interviewee: Paul Stock Location: Durham, NC
Interviewer: Callie Naughton Date: February 24, 2020
Callie Naughton: I'm Callie Naughton, a graduate student and member of the
Bass Connections American Predatory Lending and the Global Financial Crisis
team. And today is February 24, 2020. I'm at Duke’s Fuqua School of Business
for an oral history interview with Paul Stock. Thank you for joining me today.
Paul Stock: It's my pleasure.
Callie Naughton: I'd like to start by establishing a bit about your
background. I believe that you went to Duke University for college and UNC Chapel
Hill for your J.D. Is that right?
Paul Stock: Correct.
Callie
Naughton: And in the context of
your work life, when and how did you first become involved with residential
mortgages?
Paul Stock: Well, I didn't have many jobs, so I'll tell you about each
of them. I worked out of law school at the [North Carolina] legislature for
five years, just as a staff attorney, starting in 1974. They were just building
a central staff; they had only had one group of attorneys. The Attorney
General's office had staffed the legislature prior to that, but [the General
Assembly] were building their own [staff]. So, I was on a small staff of
attorneys. I did that for five years. And just coincidentally, I staffed the
banking committee.
At the end of those five years, I was looking to make a
change and the person who was running the North Carolina Savings and Loan League
moved it from Greensboro to Raleigh and was rebuilding his staff. And they also
had a new lobbyist at that time, a former President Pro Tempore of the Senate,
Gordon Allen, a wonderful gentleman, and he suggested that they seek out
somebody who had some legislative experience because he was not a lawyer, and
he wanted to have somebody who was familiar with drafting and could handle the
technical aspects of the lobbying chores, which were going to be part of the
duties of this new attorney. And there had not been very many of us, so, it was
a very small pool and I was the only fish that happened to be available at that
point in time. And so, I took that job on.
And if you remember, in my early years. there were 210
savings institutions in North Carolina – state and federally chartered. In the
middle of the 1980s, there was huge failures of savings and loans. That's
another story in and of itself. And we started at the Savings and Loan League,
offering membership to community banks. The [North Carolina] Bankers
Association had far fewer small entities. The handful of large banks supported
the organization with much larger dues and the small banks paid very little.
And in return, the big banks didn't want to provide a whole host of services. All
they really wanted was lobbying. That's the only thing they felt they got. So,
we found a lot of the community banks were interested in that offering. As you
move forward for another half dozen years, we had – most of the community banks
were members of both organizations and they didn't want to pay two sets of dues.,
even though the bank was so small.
So, an effort was made to merge the organizations, and at the
end of 1996, the two organizations voted to merge. The staff from the Savings
and Loan League remained intact. And we added one or two people from the
Bankers Association. And we took the name of the North Carolina Bankers
Association. The five largest banks pulled out, so the merger was effective the
first day of January, '97., So, leading up to the legislative initiative, our
organization – the North Carolina Bankers
Association – represented all but the five largest banks in the state. And so
even though I didn't change offices, I had that same job through the Savings
and Loan League, the League of Savings Institutions, the Alliance of Community
Financial Institutions, and then the Community Bankers Association, all the
same group until we merged with the Bankers Association in '97.
Callie
Naughton: Okay. I think during
this time, generally across the state, banks increasingly branched as they
grew. Can you speak at all to that?
Paul Stock: Well, unlike a lot of states, where unit banking was the
rule and a bank could only either have one office or only be in one county, in
North Carolina, there was never a limitation on statewide banking for either
commercial banks or state chartered savings institutions. And it's one of the
things that people felt when interstate banking was permitted – and one of the
reasons that NCNB [North Carolina National Bank] and then later Bank of America
and some of the other North Carolina banks were so successful – was that they
had already achieved some expertise in managing over a relatively far flung
geographical area. North Carolina is not very fat, but it's long, over 500 miles.
And so, if you had branches across the state, you were not in a single
community.
But during that period there was there were a couple
things that led to branch networks. Many savings institutions were either
merged into other savings institutions to try to develop some size, or they
were acquired by banks. And in a lot of cases, in the mid to late '80s, savings
institutions had been weakened, and they needed to seek an acquirer, or they
had converted to stock, and there were opportunities for financial gain for
both the communities and the insiders of the institution. So, there were a lot
of acquisitions there. So, a lot of banks filled in their geographic networks
rather than starting new branches by acquiring smaller banks and savings institutions.
Callie
Naughton: So when the two
organizations merged in '97, about how many banks were you representing?
Paul Stock: I think we still had a total banks and thrifts somewhere
in the 140 range, 130, 140, and again, back to the early 1980s, 210 savings
institutions and about 80 banks – so close to 300 total – we were half that
number in the late '90s.
Callie Naughton: Right. And what kind of services – you mentioned you were
providing services besides just lobbying. What kind of services were you
providing?
Paul Stock: Well, we had a group health insurance program, which was
important. We in fact had a fully licensed insurance agency that would offer
the sort of buying power for small institutions that big institutions didn't
need. That we could have some clout for [purchasing] their bankers bonds, and
their directors’ and officers' liability [insurance], their own property
insurance, there are specialty groups for financial institutions. And we acted
as their aggregator to get them the best possible pricing. We endorsed all
kinds of providers to them. We screened providers for all kinds of services, payroll
programs, anything you'd think of a business that size or bank in particular
might need. We felt that we saved a lot of effort.
Again, some
of our smallest institutions might have half a dozen employees. And we were
essential for those tiny groups. But even up to 70, 85 employees, we provided a
full range of compliance services, both answering questions on the telephone
and sending out updates. Every time a new regulation was passed, either the
state or the federal level. So, a very, very broad range of services. And they
were by and large, very well received.
Callie
Naughton: Great. You started in
'74 working with the GA [General Assembly] and you move over in '79, to the
Savings and Loan League, and then as you move into the late '80s and early
'90s, what were some of the key changes you see taking place in the mortgage
market specifically?
Paul Stock: Well, if I may, I'd actually like to go
back to 1978 for just a second. For almost a hundred years, the savings
institutions – the savings and loans, savings banks in the Northeast – they had
provided the vast majority of mortgage loans in this country and it was in a
very regulated environment. Regulation Q of the Fed said “You can pay this much
for deposits and you can charge this much for loans. And oh yeah, by the way,
savings and loans, you could pay a quarter of percent more for deposits so
you'd have a leg up on commercial banks because we want you to be the
aggregator for mortgage loans.” And those are the only things that they did:
they took savings deposits and made mortgage loans. And that was fine as long
as nobody upset the regulated applecart. When Wall Street started offering
money market accounts that paid a market rate for interest, all of a sudden
people said, “Well, we really liked the deposit insurance but you can't get it
on a very big account and for double the interest rate, I'd rather take a
chance.” And so, all of a sudden there was tremendous disintermediation in the
savings and loan industry.
And the biggest change, I think, that affected the housing
market was done in 1978, when Congress authorized savings and loans and banks
to offer six-month money market certificates. Now at the time, they didn't
deregulate what you could charge for loans. What they did is they deregulated
one side of the balance sheet. They said, “Okay, your costs are now going to
respond to the market, but your fees are going to stay set.” And that's what
began the great decline in savings and loans. In 1980, the federal government passed
the Depository Institutions Deregulation and Monetary Control Act of 1980,
affectionately called DIDAMCA. And one of the things they did in Article Two,
as I recall, was they passed a federal preemption of state usury laws.
And I bought a house with my new wife in 1981, and our
mortgage loan was at 15.75% with a five-year balloon. And I worked for the
savings and loan industry. That was the best interest rate I could get. Interest
rates had skyrocketed. And in many states, the usury laws – people could not
get a house period. Nobody could lend money there. They were frozen. And in one
state, Arkansas, they actually had a constitutional limit of 12% on mortgage
loans. So the federal government in that DIDAMCA preempted all those usury laws
with regard to mortgage loans so that the mortgage market, however pricey,
could still exist.
So I think in getting us again toward the end of the '80s,
another thing that happened was everybody had always had a 30-year fixed-rate
mortgage. Maybe a few innovators had a 15-year because they could afford the
bigger payment, pay it off a lot faster. The difficulty in lending in a high
interest rate environment challenged people to come up with alternative
mortgage instruments, which became a dirty word later on, but initially were
very simple things like adjustable rate mortgages that if you went to a local
bank or a credit union, it might be every five years with a cap of no more than
1% every five years. But the structure, once it was authorized both by state
and federal laws was available. As we got into more and more interesting forms
of alternative mortgage instruments, those with negative amortization as a
possibility, et cetera, the ability for them to be misused definitely became greater
and greater and greater.
And the fact that this federal preemption was in place
made it really hard for states to do anything, particularly in the mortgage
market. So, as the world economy became more and more globalized – now I guess
all of this is my take on it, I did not go to business school – but my take is
that as the economy of the world became more and more interactive and national
boundaries didn't matter, large piles of money from around the world were
always looking for the best return on the safest investment. And for about 100
years, an American mortgage was about as good an investment as you could make.
There was very strict underwriting and property values had appreciated
steadily, maybe not exactly on a straight line, but quite steadily with only a
few dips, notably during the Depression. But it was always seen as a great
place to invest.
Now, initially, savings and loans made mortgages and kept
them in portfolio. But it turned out that some places had lots of money from
depositors and not as much demand for mortgages and other places had a lot of
demand for mortgages and not as much cash around. North Carolina, for example,
for many, many, many years – and maybe still, I don't know, I've been retired
for eight now – was an importer of mortgage money. Very fast growing, lots of
demand, even though we were a pretty big financial state, we still imported our
mortgage money and that's where the secondary [mortgage] market developed.
Initially Fannie Mae [Federal National Mortgage Association] and Freddie Mac [Federal
Home Loan Mortgage Corporation], Ginnie Mae [Government
National Mortgage Association], the big national companies, and also huge
savings and loans out of California bought a lot of mortgages, big insurance
companies, bought mortgages. The secondary mortgage market grew and grew and
grew and grew.
Still, it was hard to satisfy as we work our way up
through the '80s and into the '90s, the global demand for investments, safe
investments. And because they had always these two words, “American mortgage,”
had always been such magic, the demand for that particular investment was huge.
Well, where there's a lot of demand, somebody's going to figure out a way, or
ways, to supply it. And what we know, and as we get up into where we started
dealing with legislation, lots and lots and lots of bad practices developed in
order to generate the volumes of supposedly sound investments, which were not,
to reap those funds. And lots of alternative instruments, but even more so,
just bad practices, almost all of which, I think, started off well intentioned
in small numbers.
One example was the “low doc” loan. I don't know if
anybody's mentioned that to you yet, but mortgages had always had more
paperwork than just about any other kind of loan, and the process from the time
you say, “I want to buy a house,” to when you closed your loan, seldom could be
less than a month, and it was usually more like two months. And some of the
participants in the mortgage market – I think largely board mortgage bankers –
said, "Well, you know, we ought to have a category of mortgage loans that
are so vanilla that we can make those “low doc” loans where you just don't have
to do as much. Maybe you get the borrower to tell you how much they have in
their accounts and what their salary is and this, that and the other. But maybe
you don't verify them all. You get their credit score and maybe you get a
couple of other things from reporting agencies, but you don't go back and do
the things that are so time consuming. And maybe instead of a full appraisal,
you do a property evaluation.” It's been so long now, I don't remember all the
things that went into making low doc, but it speeded up the process
tremendously. One: you didn't have to get all those things filled in, and two:
people didn't have to review as many documents because there weren't as many. Low
doc! A great idea, very bad result.
But I think the thing that truly – well, a couple of
things. You had lots of people making mortgages and the biggest number
generators were the mortgage brokers. They were a new entity. Both mortgage
bankers and banks and savings and loans all used them because they helped them
expand the numbers tremendously on the mortgages that could be made. Mortgage
brokers had no skin in any game. They got paid X dollars for every mortgage
they produced. If the mortgage didn't pay back, they didn't care. So you're
already doing low doc loans and if you've got a customer there and they're
looking at a house they never thought they'd be able to own and they'd say, “Well,
we're going to do everything we can to get you qualified. How much money are
you making?” [The mortgage applicant would say,] “X.” [The mortgage broker
would say,] “You know, I don't think you're going to be able to buy that house
with that salary. Let's just work with two X. Let's just, let's just put that
down just for arguments sake.” They just fudge the numbers. And this went on in
unbelievable volumes.
But the thing that took all these practices and expanded
it into a trillion-dollar hole in the ground was the securitization and the
derivatives. And I can't claim after all these years to still understand all of
it. I do know one thing that happened is you take this huge pile of mortgages,
a lot of which were very bad to begin with, and you divided it into tranches.
The rating agencies – also a culpable entity – would rate them from high to
low. This is AA, B plus whatever down to a junk bond level. Nobody really
wanted to pay much for those junk bond level. So, if you took all of those, you
packaged them up again, just another big pile of those, and you divided that
into tranches and you took the best tranche and you labeled that AA. So now
you've got bad stuff and you're giving it a high rating.
Appraisers [were] not getting work unless they brought appraisals
in that met the need. You can really go right down the list. Banks – in some
parts of the country, I don't know that we had the problem here – would
essentially rent their charters to non-bank entities that wanted to charge high
rates, but they didn't have the benefit of the preemptions that the federal
government had passed. You had to have some connection, you had to be FDIC [Federal
Deposit Insurance Corporation] or FSLIC [Federal Savings and Loan Insurance
Corporation] insured, or you had to be at least a seller to Fannie Mae, Freddie
Mac, the federal agencies that required financial reserves. But, a mortgage
brokerage company could work out a deal with a small community bank in Denver
and using their preemption, sell, originate mortgages all around the country in
huge volumes. And with almost no rules. They could just select the states with
no licensure or financial responsibility requirements. Anyhow, and all of this led
to a huge volume of bad loans.
But then when you take the power of Wall Street, you
aggregate [the loans], and you give investment quality ratings for lots of
them. And it was just a time bomb. It is. It's really sort of amazing. Now, I
didn't know any of this until in the late summer, early fall of 1998, I got a
call from Phil Lehman – who I know you've spoken with – from the Attorney
General's Consumer Protection Division. And he said, “We're having some issues
with junk fees charged primarily by mortgage brokers. And I wonder if you'd get
together with us and maybe the mortgage bankers and a couple of other groups
and just talk about this, maybe some of the finance companies.”
I think their junk fee stuff was primarily mortgages, but not exclusively
mortgages. So we had one meeting to talk about that. I felt like we could
address their concerns.
And then Phil's boss, Alan Hirsch called and said, “There's
really a much bigger problem. I think [Phil’s] group would be a useful group to
start discussing this. And I'd like to bring Martin Eakes over there for you to
talk to him.” And so Martin from the Self-Help Credit Union and the Center for
Responsible Lending came over, and he painted a picture for us
that was unbelievable. Absolutely unbelievable. A lot of the stuff we're
talking about – which is very believable in retrospect – in 1998, the mortgage
market is humming. It's not surprising to find because it was a such a huge
volume of dollars, that there were bad actors involved, but the scope that he
was describing and the extent to which there was malfeasance throughout the
chain of mortgage lending was shocking to us.
And again, my unique background was I started with a bunch
of mortgage lenders. So even though I was working for the banking industry and that
was largely commercial business. Sort of
residential lending was in our DNA there and I was shocked about it. But Martin
absolutely had the evidence and I listened. I mentioned Gordon Allen who wanted
me to get hired, Gordon was a fabulous gentleman, but his approach to lobbying
was not universal at all. And he felt that it wasn't a process of trying to
win, but it was a process trying to reach the best solution. Now when you have
clients, that means satisfying your client's needs, but if they're willing, it
doesn't mean satisfying all their wants.
And when we were the Savings and Loan League and again as the
Bankers Association, we were a pretty potent force in state politics and
government. And in a lot of states when these issues first arose and the
consumer advocates were seeking to get a foothold they always, I think, reached
out to the Bankers Association. In most cases, they just didn't want to talk
about it. But that was never a really our approach to anything. Gordon said, “You
know, if you can be successful and not make an enemy in the process,” He’d say,
“You can't go through a career that way, but I think you could do that almost
all the time.” So, we never felt like we had to get the whole nine yards and
our membership was very good. They understood how the person who is on the
other side of an issue today in the legislature may be your champion tomorrow,
but if you go around making enemies, it's harder to do that. So, I had a really
receptive audience.
We started those meetings and were not ready to talk about
anything we presented yet, because we met starting in September, we had a room full
of lawyers. We expanded our group. We had the brokers represented. Now, the big
banks remember, still weren't part of our group. They had their own little
group called NCAFI, the North Carolina Alliance of Financial Institutions. And
we invited their lobbyist to come join us, a nice fellow named Jim Lofton. And
he'd been a Republican operative in state government for a while. Also ran one
of the best B&Bs [bed and breakfast] in Raleigh with his wife, beautiful
place in Oakwood. And a good guy, I'd known him a long time and in consultation
with his membership – it was easy for him, he had five members – they concluded
that they didn't want to be involved in those sessions. That they would look at
whatever was put together, which in hindsight for them was a poor choice. I was
unhappy with this because they had unbelievable legal expertise, especially the
entities that were already in multiple states had expertise about how these
things would play out working in it. And it was harder with just smaller entities
to deal with that.
We were fortunate. One of the companies that was not a
member of ours was First Citizens Bank and when they acquired a savings and
loan in Hendersonville, they picked up a lawyer there who had been outside
counsel to the savings and loan, then went inside, Jim Creekman, and when they
acquired the bank, they took him on as counsel. They'd never had general
counsel in-house before. And he just happens to be a brilliant attorney, and a
really hard-working attorney. And I asked their lobbyist [Alex MacFadyen] if, even though, I explained to him – he was a
friend of mine – what we were doing. And what Mr. Lofton had told us is they
decided to, I said, “You think there's any chance you and Jim, or at least Jim
could be involved in this?” And he said, “Well, let me talk to Jim.” Jim said
he wanted to be, and so we had Jim there. Occasionally some of the other big
bank lobbyists would come by to stay apprised. But if they weren't lawyers,
they didn't want to be there because it was awful. Even if you were, it was
awful.
And we met often three or four times a week for six or
eight hours at a time. And then, Mike Calhoun [of the Center for Responsible
Lending] and Jim Creekman would leave and do bunches of drafting to send back
and bring to the group. It was an amazing amount of work and everybody got along very
well. The mortgage brokers, I think, felt a little picked on in the group. But
again, I think their contribution to the problems was disproportionate to any
benefit they had provided. These other entities had been around most of them a
long, long time and had done a lot of very positive things for the state. Now
since that time, the mortgage brokers have increased, both in the requirements
that are placed on them and I think they do a better job, and the laws are in
place to – if the current Congress doesn't undo all of them – keep some of
those same things from happening.
Of course, one of the problems is you can't rely on having
addressed the old issues. It's amazing how many really smart people would
rather steal from poor people or take advantage of less sophisticated folks
rather than use their same talents to legitimately make money and do well. Like
cybercriminals, you know, those are all such smart people. So anyhow, that's
the way it was. And we just barely had a draft completed in time for the
crossover, the introduction deadline in April of '99.
And by that time, we had a draft that I was able to take
to my members. And our members' first reaction – first my legislative committee
and then my executive committee and then my board, because this was big stuff –
was “No, we're not going to. You know we worked so hard to get most of this
stuff deregulated. We're not going to put new regulations on. We will
just refinance all of these people in North Carolina out of their bad
mortgages.” And I said, “Well, when you see the sophistication to which they
were locked into these bad mortgages, plus some of these people can't qualify
for any mortgage, mortgages were made to them that should not have been.” I
said, “You will find, I believe, that you can't do that.” And so I brought them
a lot of the material [we had reviewed in our working group,] and eventually
they said, “This is the worst thing we've ever seen.”
And they gave me pretty much carte blanche to go ahead
with the kinds of things we were talking about with the understanding that I
did have some of the attorneys from our bigger companies looking at this stuff
and having input and going back, but always with the idea of getting a product
that we could support. When it came to the end, the big three all got behind
it. We did, the Mortgage Bankers [Association] did, and the Center for
Responsible Lending and Self-Help, the Attorney General's Office supported it.
All the people you're going to be talking to pretty much supported the bill.
And at that time, the attorney general was Mike Easley, and the senator that
handled the bill was somebody you may have heard of, Roy Cooper.
And, in years after it passed here – and I'll just throw
in this anecdote – I spoke to a lot of bank lawyer groups that I was a member
of. I mean, people that I knew, but sometimes I would go to speak to a regional
group of CEOs of bankers associations like Peter Gwaltney. He was — and my boss
Thad — were all members of a national organization and they all had regional
meetings. I spoke to a couple of regional ones. Got to go to the Bahamas once
on one, which was pretty good. And when I told these guys, a lot of them were
themselves, the state lobbyists. So, they were very hands on, on the way these
things worked.
And they said, “Well, why didn't you just kill it?” And I
said, “Well, the same reason you won't kill it when it comes to your state.”
And one, they can go in and say, well, Bank of America went along with this
thing and what are you going to do then? Bank of America is your second biggest
bank or your biggest bank. But also when you sit down long enough to let them
present what they have to show, there's no not going along with it. And they
say, “Well, I'll tell you this,” – I make this up, but I like saying it – they
said, “Well, if that ever happened in our state, the Attorney General and the Senator
would not have their jobs the next election,” I said, “Well, that happened to
us too, the Attorney General is now Governor, and the Senator is now Attorney
General.” So the same thing happened there.
The passage of the law was very, very easy. With the folks
lined up, there was never a close vote at any stage of it. It was so complex.
And the thing that made the complexity of the drafting so hard was all these
federal preemptions you couldn't just say, “You can't do this. You can't charge
this. You can't do that,” because all these federal preemptions were in place.
You could prohibit certain entities from doing certain things, but that
wouldn't come close to tackling the problem. And so, we had to create something
brand new and it took a long time to do it and some really talented
draftspeople. And I mostly provided the cookies and the board room that we met
in and tried to keep everybody in good humor. And there were times when it was
better, then times when it was worse. But the work that was put into it by
everybody involved was truly amazing. Thousands of man hours. And I think we
came up with a creative product. It was much more complex [than it should have
been]. You spend all these years working for simplicity and understandability
and this was very complicated, but it really made it hard for a predatory
lender to work in North Carolina. So, it was something I think we're very proud
of. Did I answer a bunch of your questions in one long speech? I'm sorry.
Callie Naughton: It's great. That was wonderful. When you think about the
law now looking back, do you think it prepared the state for the change – we
talked about the changes that happened in the '80s and '90s, but we also know
that there were more changes coming around the corner in the early 2000s. Do
you think the law prepared the state for those changes?
Paul Stock: Well, I think we addressed the particular issues to the
extent we could do it in North Carolina. There had been another fight going on
around the same period of time over payday lending and that was also
successful. And we got involved in that a little bit. And although it was not
something that our members were doing, but because it was it was usury-related
and that had been a field that we'd done a lot of work in, we were consulted by
a lot of legislators on both issues and we were always able to say “Nothing
that puts people already in stress in worse stress is a good thing.”
But payday lending had a very powerful message, and they
had no trouble getting testimonials from customers. They set up in strip malls,
and they were friendly to the people when they came in, and they didn't break
their legs if they didn't pay, but they kept them in this cycle of debt and
they managed to extract. And in a way, predatory lending was just that on
steroids. It's just the same thing. I think we did all we could. I think the
fact that a few other [states] started doing it, and the fact that – as Martin
explained to me in '98 – this [collapse] was already inevitable. The volume had
gotten so huge. It was just a matter of when it was going to happen. So, I
don't think we could prepare for that. And you didn't know how bad it was going
to be, but you knew it was going to be really bad.
I remember – one of my bad habits is I like to gamble
sometimes. And I remember going to Las Vegas after the crash and I had read
that 25% of the properties in Las Vegas were in foreclosure. But [I couldn’t
relate to] that [number] – you just didn't get a feel. So anyhow, instead of
taking a taxi to my hotel, when I got there, I said, “You got time to spend an
extra 30, 40 minutes? Drive me around. Let me look at all these places that
were under construction and had stopped or whatever.” And he said, “If you're
paying the meter, I’ve got all the time.” And we drove around and it looked
like a movie about a dystopian society after some sort of Armageddon. I mean,
all these places where the, you know, the PVC pipes come out of the ground up
to where they were, 20%, 30%, 40%, 50%, 60% completed. These huge condo
developments, individual houses and just stopped. There were many, many, many
places around the country like that. So, in a way, I think it's a huge
testimonial to the resiliency of our economy that – we're not ready for the
next bubble, the market was down 1,000 points when I last looked – that we've
come as far as we have. In 10 years, I'd say we really had recovered from it,
and it was a deep hole.
Callie
Naughton: You were talking
earlier about some bad practices you saw developing in the '80s and '90s. Were
your members participating in those bad practices? Were there low doc loans or
some of the other innovations?
Paul Stock: No, I mean, you know, during the, the '80s and early '90s
with our small bank membership, the savings and loans typically were still
doing things the way they always had. And the smaller community banks, some of
them got into mortgage lending, but not in a big way. They were primarily small
business banks. I think some of the bigger banks had mortgage companies and I know
some of them had finance companies and did a variety of things. But our
membership, I can't say they were 100% pure, but I'm not aware of real
involvement. One of the larger community banks, I think, had a mortgage company
that might've made Martin's list. And I talked to their lawyer about it, and I
think they divested that company before we got the bill passed is my
recollection. That's a long time ago.
But, I would not say – now it could have made the problem
much more politically difficult for me if they had been invested in it. I can
honestly say at both my legislative committee, my executive committee, my board
meeting, which are kind of increasingly large groups, everybody was appalled
when you could finally convince them that these practices were out there. And
even then, we weren't talking about the derivatives and all this stuff. We were
just talking about the lending practices and the extent of it. I didn't feel
myself competent to educate people on the extent of the problem. I just told
Martin I hope he was a lot dumber than I thought he was and that he was wrong,
but I never thought that was the case.
Callie Naughton: Did that change in the early 2000s? Did your clients start
extending into this space at all? With ARMs [adjustable rate mortgages] or
negative amortizations or anything like that?
Paul Stock: There was definitely ARMs.
ARMs became very popular.
Callie Naughton: And what kinds of ARMs, just to clear? Like 2-and-28,
five-year ARMs?
Paul Stock: I think it varied tremendously, not much in the way of
negative amortization. The savings and loans and community banks dealt with the
clientele that, by and large, did not have to buy on negative amortization. One
of the scary things is in the in the ‘90s and early 2000s a lot of the lenders
were lending on expensive homes on mortgages that had negative amortization.
And, sufficiently controlled, if a young couple with two professionals that are
working, are just a few years out of college, but they're in steady jobs and
they want to buy a little more home than they can afford, maybe they want to
start a family soon or whatever, and they're in a mortgage that adjusts every
five years with a maximum of 1%. It's a whole different world to adjusting
every year with no limit. I can't say that I know of any of our members ever
getting into them.
If you're a mortgage lender by history and profession, you
know that's a recipe for disaster. Even when some of the savings and loans
started selling more of their mortgages, which the bigger ones did, making good
loans was just a part of who they were and some of them packaged loans and sold
them with recourse. So, you know, they didn't want to have bad loans. And plus,
if you sold a lot of bad loans – the theory was – you wouldn't be able to sell
any longer to Fannie and Freddie and whoever your investors were. You know, I
can't speak to the mortgage banking industry. I'm not sure what was going on
there. Given the way their business worked, I'd be surprised if they were doing
large volumes of them either. And I think there were a lot of brokers selling
to aggregators, and I don't know who those aggregators were, who then packaged
them and sold them to Wall Street. I really don't know. And some of your other
folks that you've talked to I think would have a better feel for that.
Callie
Naughton: By aggregators, you're
talking about finance companies that are not chartered as banks?
Paul Stock: Correct.
Callie
Naughton: We spoke before about
some changing underwriting standards as well, that underwriting standards
evolved over this period. But just from your point of view, do you think that
was driven by brokers? So, we have this group of brokers that are kind of
trapping appraisers, right? You'd said like, appraisers might not get work
unless they're willing to play the game with brokers. What do you think drove
those changes? Was it brokers? Was it the whole group of them?
Paul Stock: That's really a good question. Again, some of the
practices I think started legitimately, and if your underwriting is still
solid, you can do lots of things to speed up efficiency, to improve efficiency,
without making the underlying loan bad. But if you couple that with falsifying
information – and I again, it may be just my recollection, but my recollection
is that the biggest part of that problem was coming from mortgage brokers.
Callie
Naughton: There's an element of
outsourcing maybe that was happening with, between mortgage brokers and whoever
they were selling to.
Paul Stock: Everybody. In hot markets,
which was everywhere during a lot of these years, the brokers offered a cheaper
method of production, seemingly, a cheaper method of production that was really
very expensive. But you didn't know that for a while. It's hard for me to see
how the savings and loans or any people that had been in the mortgage
profession and had substantial investment, had their own skin in the game, how they
could purposely falsify the information. The false information, the false
appraisals, all those things, you knew you were making a loan that was unsafe.
You knew you weren't producing an investment for whoever ended up with it that
was going to be worth what it looked like on its face it was worth. So, I don't
see how any companies that had an investment in [the final product] could or
would want to do that. But that's always the way I've looked at it.
Callie Naughton: One thing our project is interested in is, is how do
people learn about these problems? We spoke with Phil Lehman last week and he
talked about how he had consumers, he had people calling him and saying, “I
have this mortgage I don't know how to get out of it and it's a problem.” Or “I
had all these fees on my mortgage and I didn't know that was going to be there.”
So that's how he learned about it. Besides sitting in a room with Martin Eakes,
how did you learn about what was going on? How did that evolve over time?
Paul Stock: Well, I have to say that it really was first started with Phil
in the junk fees, and then it was total immersion with Martin. I didn't get to
wade into it gently. I mean I felt like I was drinking from a fire hose pretty
fast, so I did not become aware of this from my members until I started
learning about it. I’d bring it up in my legislative committee and some of my
members would say “We're really having a problem with appraisers. Either
they're so busy they never get back to you on time or if they get back to you
on time, you really feel like they didn't do the job.”
And I will
say, there was something that I think crept into our industry, and I think it
may have come from the mortgage brokers in a way. I think people started paying
incentives to originators. And that was not intrinsic to the savings and loan
industry over the years. But when you're out hiring mortgage originators,
people to make mortgage loans and other people are paying the same employees an
incentive for every one they close, all of a sudden, you're having trouble
hiring if you're not doing that. I think that had crept into the industry. I
don't know that it was universal yet, but I think it was. And of course, once
again, then once you're getting paid to close the deal, you're getting an incentive
to do it, so maybe you're a little more inclined to cut a corner or two and
bend a rule. So that may have happened.
But mostly what I recall is members, once I brought it up
to them, they said, “Yes, we are starting to have that problem.” Now, that's
not necessarily the kind of thing I would have heard complaints. The
regulations on appraisers were not really much in place yet. They came in. It
seems like maybe some of those came in with FDICIA [Federal Deposit Insurance
Corporation Improvement Act], but I can't remember for sure. So, it was not a
regulatory kind of thing. It was just that they weren't doing it right. But my
recollection is I raised these issues with them and then I got feedback from
them saying, “Yeah, we are seeing these problems in some of those areas, but
it's from service providers.” And of course, I know if they were doing
something wrong, they're not going to come to me and say, “Well, we're doing
this too.”
But we always did surveys of various sorts, and savings
and loans because they were traditionally so heavily regulated. Banks and
savings and loans were regulated differently [from] their beginnings. Banks
were given sort of a framework in which to operate and then were told to go be
good bankers and savings and loans were told how to open the mail, which end you
put the letter opener in, and their regulations were unbelievably specific. I
want to say that there was a [publication] that the national savings and loan
group put out, The US League of Savings Institutions, called the Federal
Reporter and it was all the federal regulations [applicable to the savings and
loan industry]. There were six volumes this size. And they set out monthly supplements
to all of them. And that was just one of the services my predecessor on the job
had. He had five or six – some of which were totally unnecessary – but five or
six services, a full bookshelf of them. And they were without a lawyer for
eight months. And first day on the job, there were all these boxes stacked up.
I started unpacking and there were months and months of the supplements to
those, you know, they were tissue paper thin. It was horrible.
But savings and loans were told everything from A to Z.
And so, they were used to being told how to do something and they didn't change
their procedures very easily. Now one thing that did happen in 1977, the North
Carolina Legislature, before my time with the savings institutions, and it was
not anything that I was involved in – interestingly, I'm not sure what
committee... probably came through Finance – but they passed a law permitting
state-chartered stock savings and loans. Prior to that time, all savings and
loans were mutual. They were like a credit union except they were taxed.
Callie
Naughton: Can you describe the
difference between stock and mutual?
Paul Stock: Yeah. It's huge. It's a huge difference. Let's say this,
if you were on the board of directors of a savings and loan, pretty much what
they gave you for your service, you got to go to the annual convention. Every
year we'd take 1,500 people to an annual convention because they all brought a
bunch of directors. They might get $100 a month for a board meeting, maybe $50
a month. The CEOs in many, at least little ones, they earned less than a
mailman. They were not lucrative operations. They were seen as a public service
in many, many ways, almost like utility. I mean they were regulated like a
utility. They told you how to do everything. They told you how much you can
charge and how much you could pay. So, I mean they grew up in such a controlled
environment.
But the people who started these stock savings and loans
were different. They were entrepreneurs. There was nothing wrong with it. In
order to evade – avoid is probably a better word – avoid federal regulation, a
private insurance company had been formed, the North County Mutual Guarantee
Corporation and so they didn't have to follow FSLIC rules, the Federal Savings
and Loan Insurance Corporation. It was the thrift counterpart of the FDIC until
they merged them in '91, I think it was, maybe earlier. And they didn't have to
follow those rules. They were not subject to Regulation Q. So, they charged, I
think at this time, saving and loans we were paying 5%, they pay 6% on savings
deposits. So, they managed to exacerbate the federal thrifts disintermediation.
But in the mid '80s, when the savings alone crisis hit,
the guy who was running our private insurance, a fellow named Don Beeson – a
very prominent lobbyist since then – but he was running the private deposit
insurance corporation. And I remember he called [my boss] and me into his
office. And the first thing he did was showed us their plans for expanding
nationally. And then he said to us, “We've got to shut this thing down.” He
said the first thrifts that are going to start to go under [are those that are
not federally insured], and he said, “Would you help me work with the FSLIC to mass
convert all these privately insured institutions to FSLIC insurance?” And we
managed to do that. And his foresight [was crucial], because I want to say in
Maryland, their fund failed. And there were a lot of the thrifts that failed
there because of it. And we weren't unscathed, but it was a minor thing.
But based on the pressure by North Carolina, other states
authorizing stock-chartered savings and loans, the federal regulators, the Federal
Loan Bank Board, authorized federal thrifts to convert to stock, and then
eventually authorized de novo stock institutions. Well, if you don't have an
ownership in your institution, which mutuals don't,
and you don't have stockholders, your drive for profit is less. You still want
to be profitable and you want your board to pay you more money. And you want to
have a good career and you want to grow your institution. Just all natural
things. But when you don't have stockholders who are your ultimate
responsibility … improving their investment, making money on their investment,
it is a different outlook.
And so as the industry converted to stock, it did drive
the need for profits, which I don't think I mentioned earlier, but the first
thing the feds did when was to deregulate the deposit side. You can have six-month
money market certificates. Well, when this started leading to all kinds of
problems and they had to make more money in order to fund these liabilities,
the Fed said, “Okay, thrifts, we're going to give you all these expanded
powers. We're going to let you make commercial loans, or we're going to let you
have ‘now’ accounts – not commercial but checking accounts.” And so, some
thrifts handled it well. They hired experienced commercial bankers and they
moved into these other things. Others thought, well, maybe the S&L guy had
been a banker and had as a young banker, had been hired to run the S&L and
he'd spent 40 years at the S&L and thought he knew enough to be a
full-fledged CEO of a commercial bank, but didn’t really.
And so, a number of them got overextended and made loans
that a commercial bank wouldn't make. And that should have been probably a tip,
but it wasn't in a lot of cases. So, all of that added to the savings and loan
crises. But I would say that the community banks were not as big participants
in the mortgage market to begin with. And those that were, were not major users
of, I would say, the more extreme alternative mortgage instruments. Yes, all
kinds of variable rate mortgages and adjustable rate mortgages, I think those
things were very widespread. There was a time that even the State Employee’s
Credit Union wouldn't make a fixed rate mortgage. I think that may still be
true. But they have a very reasonable – I think it's typically a five-year adjustable
with a limit on the increase in five years – but the savings and loans here at
least were not vigorous users of anything too exotic.
Callie Naughton: Just to move us toward some concluding questions. Let me
just check some off my list here. Over the last decade we have seen a number of
different narratives emerge to explain the financial crisis. How do you
understand what caused the crisis?
Paul Stock: That is a summary question. I would say the huge demand
for investment in the American mortgage market fed a less than properly handled
explosion of investment opportunities and the combination of declining product
standards and the power of Wall Street to cover those weaknesses. And I, again,
I don't claim to have great knowledge of how the rating agencies work, but how
they could put investment grade or any positive ratings on these volumes of
just garbage. I would say that's the single biggest factor in making it such a
global crisis. The lending practices themselves were at least equally as big in
making it – in building the problem in the United States. But I think that the
Wall Street involvement was the single biggest thing in making it a global
crisis.
Callie
Naughton: How do you see your
personal experience adding something important to our understanding of what
happened in the run up to 2007 and 2008?
Paul Stock: Well, I don't know – it's interesting – I'm not sure how
different my perspective will be from others. I know that I was unusual in
being at a role in a large state banking trade association, having a history
with a mortgage lending institutions like the savings and loans, but I also
think that I was very fortunate in that our policy-making leaders were not
interested in just winning a legislative fight. They were really willing to
understand why the problem was bigger than some fraction of a percentage point
on their bottom line. I felt humbled by the way our membership as a whole was
willing to be reasonable about it and let us stay engaged. I don't know that I
would have found that true in many other states.
I'm sure there would be some others, but I think that I
was glad to be involved and I made some lifelong friends and learned a great,
great deal. But I certainly wasn't the primary draftsman and I wasn't the creative
force behind it. I did come up with a couple ideas which I won't take credit
for it because I probably would not be popular with people I would like to stay
popular with, if they knew it was my fault. But it was a very interesting
process. The 2007, 2008 wasn't interesting. It was horrible. But a lot of
people were already suffering before 2008. The people that personally were in
these bad mortgages were suffering all throughout the 2000s. And it was just
when it finally got to the tipping point when people realized what that volume
truly was, that the whole house of cards came down.
Callie Naughton: Looking back on the crisis over a decade later, what do
you see as its most important lessons from mortgage originators and state level
policy makers today?
Paul Stock: You know when you – it seems so obvious immediately
afterwards that when you develop sound practices for making a certain product
useful and valuable to everybody involved: the seller, the buyer, the investor.
You spend a hundred or more years figuring out what really works well, rapidly
changing 80% of those practices in a short period of time might lead to some
problems. It seems so obvious, but, you know, I think a couple of things. One,
I think it's fine what the federal government did in response. I think some of
the stuff they did, it's not clear to me how exactly it related to the crisis.
Again, the, the federal response was so much more complex than our state law
although they did follow our structure in a lot of ways and things that we were
able to address, which is not surprising because Eric Stein was one of the
primary drafts people on that project in Congress, Josh Stein's brother, and a
former leader at the Center for Responsible Lending. He was in DC for all of
that process. I think the long arm of North Carolina's efforts was very
involved.
I think the only risk is believing that because we address
the problems of the past, we've taken care of the problems of the future. One,
other problems will come because things happen in the economy that haven't
happened before, so you can't prepare for them. And secondly, no matter how
hard you work to address criminal undertaking and just shoddy financial
practices, maybe that don't rise to the level of criminal, some folks are going
to cut corners and others are going to use their substantial intelligence and
assets to try to cheat people rather than be honest. And so there will be other
crises. I would hope that we won't see – I doubt that in my lifetime I'll see
anything that big again. Although like I said, the market was down a 1,000 last
time I looked. I think that the response was appropriate in its extent. I think
that the things that I do understand were appropriate in the approach, but I
think that the best takeaway is to not be comfortable that we've kept this from
ever happening again. We may have kept this from every happening again, but
there's a “that” in our future and we probably haven't gotten to address “that.”
[END OF SESSION]