AMERICAN
PREDATORY LENDING AND THE GLOBAL FINANCIAL CRISIS
ORAL HISTORY PROJECT
Interview with
David Stevens
Bass Connections
Duke University
2020
PREFACE
The
following Oral History is the result of a recorded interview with David Stevens
conducted by Sean Nguyen on March 3, 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: Sean Nguyen Session: 1
Interviewee: David Stevens Location: By phone
Interviewer: Sean Nguyen Date: March 3, 2020
Sean
Nguyen: I'm Sean Nguyen, an undergraduate student at
the University of North Carolina at Chapel Hill and member of the Bass
Connections American Predatory Lending and Global Financial Crisis team. Today
is March 3, 2020 and today we're joined by David Stevens, currently the Chief Executive
Officer of Mountain Lake Consulting Incorporated, and Dave has joined us via
telephone today. Thank you for joining us.
David Stevens: Great to be here, Sean.
Sean
Nguyen: And so, before we begin, I'd like to start by establishing
a bit about your background. I believe that you grew up in Connecticut and went
to the University of Colorado at Boulder for college. Is that right?
David Stevens: That's correct, yes.
Sean
Nguyen: And so, in the context of your work life, when
and how did you first become involved with residential mortgages?
David
Stevens: It was after college and I was working for a
nonprofit, and honestly, I just needed something that paid me a little more
money, and a friend suggested, he had just joined a mortgage company, World
Savings, and suggested I interview, and I did, and was hired, and that's sort
of the fluke of nature and I think it's pretty common in the mortgage business
that, at the entry level, it's oftentimes accidental that people come into this
business.
Sean
Nguyen: And so how would you characterize the key
changes in the national mortgage market between when you first became involved
with the mortgage market? And what year was [it when] you got involved?
David Stevens: 1983.
Sean Nguyen: So how would you characterize the
key changes in the mortgage market from 1983 to 2008?
David
Stevens: Oh, it's dramatic. When I began in the
business, there were no automated underwriting systems. There were no FICO
[Fair, Isaac and Company] scoring models. Even the GSEs [Government Sponsored
Enterprises] were a fraction of the size they became at the peak of the market.
There was really no private label securitization market per se. I worked for a savings
and loan, every loan we originated, we underwrote, we analyzed the credit.… You
stood in line at banks to get verifications of deposit that would show the
money's needed to settle. Our underwriters were all in-house. The loans stayed
on our balance sheet. We took all the risks. Our appraisals were done by in-house
appraisers who did a lot more, I think in many ways than they do today in terms
of establishing risk.
…[T]he risk paradigm
was significantly different because we held it all. So even though in the early
'80s, because we were coming off of the oil patch recession and it was an
inflationary recession, interest rates had just reached their peak at about
18%. Thirty-[year] or fixed-rate loans were in the mid-teens, so you could get
a fixed rate for 16% or 15%. Variable-rate mortgages were really the product
that was the predominant program. And so managing the risks associated, that
was pretty significant. We all had cameras given to us by our company, and we
would have to drive [to] every home that we did a loan on and personally take a
photo of it, and fill out a form about the condition of the property. Because
in those days, it was about equity and the value of the collateral. There was
really no high LTV, high loan-to-value lending, or very little of it. Most down
payments were much higher. And FHA [the Federal Housing Administration] would
fill in the gap, but not all lenders did FHA loans, so it was just a very
different environment.
In fact — not that this is necessarily relevant
— but even with adjustable-rate mortgages, there was no consistency. Some are
called ARMs, some are called VRMs, variable-rate mortgages, some are called
AMLs, adjustable mortgage loans, depending on which bank you talked to, they
might have a different index, a different initial rate, different cap
structure, a different margin over the index. So there's no consistency because
there was no securitization market, each bank created their own proprietary
products. And so it’s this very different world until automated systems and
capital markets became the way the business was run. And that didn't even start
building until the mid-1990s. So it was a long time before we got to that
point.
Sean
Nguyen: To what extent did you and others in your
organization see the changes that were occurring?
David
Stevens: See? Oh, we saw it. It was dramatic. The
challenge, what ultimately led to the crisis, … was an extended, decades-long
improving credit environment in real estate finance. Homes started becoming a
sure thing in the early 1980s and literally, we never had a recession that
tested that. And so, as lenders grew more confident in real estate and others
wanted to get into that market, which included Wall Street firms, international
investors, pension funds, and more, the exuberance over real estate allowed for
just the continuous relaxing of standards such as layering of risks.
So, for example, pay option ARMs
[payment-option monthly adjustable-rate mortgages] was really an answer to the
oil patch crisis that took down the savings and loan industry because they had
lent long on 30-year fixed rate loans, but the inflationary environment that
ultimately drove rates high was that the short rates became more expensive than
long rates, and all these S&Ls [Savings and Loans Associations] were
underwater because they held long 30-year fixed rate loans on their balance
sheets. So the reason why adjustable-rate loans were primarily introduced was
not to market them per se, it was because coming out of that crisis, $350
billion, it took down companies like Lincoln Savings [Bank] and had all sorts
of its own housing crisis, mortgage finance crisis that no one really pays
attention to anymore because we've been through a worse one. It was to get a
match, a basis match, so something that would adjust more in sync with your
deposit costs. And so, that was the onset of the adjusted rate mortgage.
But, it was compensated for
with much stricter underwriting standards, loan- to- value limitations, not
deeply discounted teaser rates, that ultimately became the case. What we saw
over time was everybody wanting to get in on that business. And so Countrywide
[Financial] as an example, which I remember it as a tiny company, and just saw
it balloon, but they came the loss leader of that particular product for
example, and ultimately, leading up to the recession, they would do those loans
with an 80% loan-to-value with a 20% second mortgage, meaning it was 100%
financed. That's one big layering of risks — so you lost all the equity
protection in the event of default — and they would allow them with more lax
underwriting standards, higher debt-to-income ratios, less than pristine
credit, and those kinds of things.
So ultimately what we saw,
what I saw happening from the origins of your dad's banking world or whatever
you want to call it, was we went from a very hands-on, slow-moving, risk-focused
portfolio lending market to the massive emergence of players that came in to leverage
the secondary market, the growth of the GSEs, and once companies realized that
they can offload their credit risk to a Freddie [The Federal Home Loan Mortgage
Corporation] or a Fannie [The Federal National Mortgage Association],
and then ultimately, Wall
Street, decided they were going to get in that space and aggressively target
loans that were typically Freddie and Fannie eligible. The rule of the day as business
went on for lenders across the country was: if the investor will buy it, you
can originate it. And, with really no responsibility to determine, in general
terms, whether the loan was sustainable or not because – one, we had had a …
two-and-a-half decade or two-decade environment of no risk; actually, close to three-decade
environment of no risk in the residential real estate [market] in the United
States and a progressive laxing of credit standards, but yet no incidence of
default because we hadn't had any significant recessions. There had been,
there's been the 2000, the 1994, I mean there were little short-term pockets of
correction, but we had no real testing of any of the credit standards, and that
just piled on.
And that built ... an
industry that grew into mortgage brokers, and independent mortgage bankers,
non-bank lenders. They were there back in the day, but never to the extent they
… are today. And not that that's bad or good necessarily, I'm just saying that
became an outcry because you no longer needed a balance sheet to lend money.
You didn't have to be a bank. You could open up an independent, non-bank
company, whether it's Countrywide [Financial] or Quicken [Loans Inc.], or some
of these megas, or smaller companies that exist today, because you could
always sell those loans to Freddie or Fannie or sell them into a Ginnie Mae [The
Government National Mortgage Association] security, using FHA, VA [US
Department of Veterans Affairs] or USDA [US Department of Agriculture] …, or
sell them into the private label securitizations market. So, obviously massive
change, and it was right in my windshield as I watched it.
Sean
Nguyen: You mentioned Government Sponsored Enterprises,
such as Fannie Mae, Freddie Mac, and I'm aware that you transitioned from World
Savings to Freddie Mac, I believe in 1998. Could you talk more about that
transition and how your responsibility shifted from your role in World Savings
and when you went to Freddie Mac for those seven years?
David
Stevens: … I started, as I said, by accident. You do
that job for 17 years, or however long, and I forgot how many years I was
there, ‘83 to ‘98…. And I progressively grew up through the ranks of this bank
that was growing pretty dramatically and I was group Senior Vice President and
running a very large chunk of the company. And, I really, at that point, was
interested in expanding my horizons in terms of knowledge. I was still young. And
an executive recruiter reached out to me to consider an interview at Freddie
Mac; and to me that was the perfect balance. I'd spent a long time in the
primary market. Freddie Mac is the secondary market. Freddie Mac doesn't
originate loans, they buy loans from lenders. I went from a portfolio lender
that did very little business with Freddie, and I wanted to learn about how the
rest of the world was operating in mortgage finance. And, in those days,
Freddie and Fannie were large, powerful, dominant institutions, and did
business with the largest banks in the nation.
And so when I went in as
Senior Vice President, initially to head sales for Freddie, ultimately within
just a pretty short period of time, I was promoted to be the head of all Single
Family[1]. But,
my responsibility was to essentially drive the business that would come into
the institution. Freddie was a very different experience because, one, I didn't
understand how MBS, mortgage backed securities, were structured. I didn't
understand, buy ups and buy downs, or the dynamics of TBA [forward-settling
mortgage-backed securities trades], and hedging and all the aspects that are
involved in the secondary market. I learned it now, but I really was an infant
coming into that job. I came in as a guy with really strong sales and
communications and business management experience. And the initial goal was for
me to help improve the perception of Freddie with clients around the country
and be more engaged and be more, for lack of a better word, sales-like, to
augment the strong capital markets and at the time what was considered to be
superior risk management skills at Freddie. And so … there was a team there,
and so whenever you're negotiating a deal, back in those days you would write
contracts. So Wells Fargo [Bank] would come in once a year. Wells [Fargo Bank]
is our biggest customer, so you'd meet with them constantly, but about once a
year we'd renew an annual agreement. It would be a contract, would be a very
extensive contract. And we'd bring in the Chief Risk Officer of the company,
the head of capital markets, the head of affordable lending, the whole group
and the President of Freddie would be involved. Ultimately, it would be
presented to the President and CEO, the final deal, before it got approval. … [I]n
those days, you'd end up writing a couple hundred-billion-dollar contract with Wells.
I think it was actually, in its biggest year, if I recall, it could have even been a $400 billion
contract I wrote for one year….
And so, we had an
organization that would call on small lenders. And then I called that community
lending and … they'd call in 10 to 20 community banks or independent mortgage
bankers. And they had, for a company like Wells, I had a team on Wells with one
lead and a group. Because they were a market segment unto themselves. I will
tell you that the experience, and I've talked about it openly, between Freddie
and Fannie was very destructive to the housing finance system.
Freddie Mac was the first to
strike, but they created, in an effort to grab market share, created what's
called alliances. We cut a deal. I think Wells was the first one, where in
exchange for credit terms and pricing terms, credit variances and pricing
variances to the normal structure that we would give to the lenders, we would
get all their business or the majority of it. And I think Freddie struck first.
Fannie then struck with Countrywide, and it became a domino effect with the
largest lenders. That was really a race to the bottom, ultimately, because
Countrywide and Wells and companies that don't exist today, like ABN AMRO
[Bank] and others who were huge at the time, Washington Mutual [Bank], of
course, JP Morgan, Bank of America, you name it, they were all in there. But
there were other players that were huge and do not exist today. But they would
use their leverage to say, “You either give me these terms, or I'm going to go
to Fannie.” And this duopoly became actually very destructive. I'm not a fan of
the duopoly as it stands now because ultimately you had shareholders really
pressuring you to get the market share high enough to keep liquidity in your
mortgage-backed securities because we had a different security than Fannie's; because
investors and shareholders needed to see that.
And as a result, products
were created as a tradeoff to getting these market share deals that never
should have been in the market in the first place. Yeah, I still remember them to
this day. The fast and easy loan that Countrywide had, allowed borrowers to get
a 30-year fixed-rate loan that went into the regular mortgage backed securities
market, standard TBA pools. But if you had a certain FICO score, you didn't
have to have any documentation at all. No verification of anything. And these
kinds of things really eroded credit standards, on top of what was happening on
Wall Street. So, it was just an interesting time.
Sean
Nguyen: How would you describe the key goals of Freddie
Mac in the years before the housing boom? Before the 2000s really took off. And
did these goals change in any way during the boom?
David
Stevens: Well, the stated goals were pretty
consistent. And we had scorecards, so we were all measured on and paid against [them].
And my goals were not dissimilar from the head of credit risk or capital
markets because we all ultimately wanted to accomplish, in the very early days,
returns to shareholders was the goal. X percent, I can't remember what it was,
but we had goals to give a certain return to shareholders because you're a
public company; in our view, completely public. I think the fact that we had a
government wrap on our MBS [mortgage backed security], it was just a side
effect, side benefit, but we never thought [of] ourselves as quasi-governmental
or anything like it. We were viewed as, again, private entities. So return to
shareholders was preeminent. But we also had political risk and a lot of it. …[U]ltimately public companies that are shareholder owned,
ultimately, their number one goal is to return value to shareholders.
And so subsidizing mortgages for
underserved communities that are clearly higher risk and bring in lower
returns. It would only be done in a normal environment— in a Freddie Mac and
Fannie Mae world of this — because of political pressure, affordable housing
goals that the Congress demanded be in place. And frankly, that's a whole other
rabbit hole we can go down if you want to, but that was very much of a gamed
system and I'm not sure it ultimately accomplished what it should have. But it
certainly allowed Freddie to make public statements about what it was doing in
affordable lending, as did Fannie. So yes, our goals would be shareholder
returns, general administrative expense controls, market share, affordable housing
mix. So that kind of objectives would be standard for us.
Sean Nguyen: To what extent, if at all, did
your organization express concerns about the changing nature of credit
extension during the 2000s?
David
Stevens: Yeah. You know what, people in our organization
did. I will tell you personally, I raised concerns about other things. I was
very concerned about the disparate impact to smaller banks that was happening
because of these deals being struck with the big guys. And so, I wasn't looking
directly at the credit …but it did happen and I will tell you that, the Chief Risk
Officer at the time, there were two of them, Don Bisenius and David Andrukonis.
But Don and — poor Don got an SEC [Securities and Exchange Commission] letter
after they went into default and he never showed up, and it's all been cleared
to this day — but Don was the one when he saw these waivers being ultimately
agreed to which would go to the president of the company. And again, it was
equal over at Fannie, equal or worse. But I remember Don once saying, “When,
when we finally go into a true correction, we're going to be driving trucks up
to these lenders and returning all of these loans that have misrepresentations
in them, defects we call them.” And the rationale there was Don felt concerned
that we were — yeah, all of us — the market was too extended in credit and that
there wasn't enough due diligence happening on the individual loan transactions
being delivered through a Freddie Mac security, by many of these lenders, and
it was his assumption that in the event of default, in looking at these loan
files that there would probably be errors — what we call defects — and that
would be a cause for repurchase. And so that was Don's humor about — I don't
think it was humor, it was more foreboding humor that … there'd be a lot of
defaults, marked across the market if we ever had a correction.
I want to go back a second if
you don't mind. FICO as a model was invented in 1993 if I recall. And it was, I
remember when the credit scores came out….[W]e talked about in our bank, “We'll
never use a credit score. It doesn't do the same as actually reading your
credit report.” And, of course, proven well wrong, but that, that was the
beginning. Then automated underwriting systems, the first of which was Loan
Prospector at Freddie and then Fannie's Desktop Underwriter. That rolled out in
1998 or 1997, maybe something like that, something in that range. And so, when
I joined Freddie, automated underwriting systems were just beginning to boom,
but it boomed overnight and, literally, banks had AUS, automated underwriting
systems, AUS systems embedded in their underwriting logic within a couple of
years. Everybody from that point forward were originating loans on models. The
model was FICO and data-driven decision making through an AUS that had never
been tested and we had never had a recession to run it against.
Sean Nguyen: And what year is this development
happening?
David
Stevens: I Oh, it's late '90s, is when it's really
beginning to happen, but it boomed. It was an explosion of technology
advancement that burst through the system through the industry. And the reason
is just, Wells always had an internal underwriting system called, at the time
it was called ECS and all the other big ones had their own systems too, [I'm]
just using Wells as an example. And they manually took Freddie Mac's
underwriting guidelines, which were basically a big manual, we had a big book,
HUD does too, FHA. Every big buyer of mortgages has a big underwriting manual
of standards. It probably still exists at Freddie in paper form perhaps, I'm
not sure. But big banks, in order to create efficiencies, would try to take the
majority of those [underwriting guidelines], they would then manually input
them into their system, was called ECS [Electronic & Commercial Services],
and they would try to get as close as possible to what they thought the real
guidelines were.
So when Freddie introduced
its own underwriting system, which said, “If you go through our system and it
gets approved, you're good as gold. I mean, you don't even have to worry about
whether you got your system right, because we're guaranteeing ours, we'll buy
off of ours.” And you suddenly eliminate all this repurchase risk. So the
moment Freddie developed their system, everybody just wanted to get that damn
thing embedded in … their own logic, rather than using their own systems that
they've manually kind of put together based on how they read… the guidelines
from Freddie. So it was really quick. And I sort of came into Freddy when that
was all happening and saw it grow. And today, obviously automation is moving at
an extraordinary track on all levels and all aspects of the manufacturing of a
mortgage, but that was pretty big at the time.
The reason why I often focus
on that is, like all these things, nothing had been tested and the entire
mortgage market, multitrillion [dollar] market with investors globally and
people's retirements invested in them in pension funds, whether in Ireland or
in Cleveland – [it] didn't really matter. They were all backed by these
mortgages that were now being automated on a lot of automated credit evaluation
technologies that had never really been tested against anything. And the
pooling of mortgages was all determined by Freddie and Fannie. So if Freddie
determined – if Freddie had 30-year fixed-rate loans, whether they were 99%
loan-to-value or 100% loan-to-value or 50% [loan-to-value], they would all get
pulled into the same TBA security and investors would buy a big security based
on weighted averages; WAC, WALA, all these kinds of things — weighted average
coupon, weighted average loan amount, weighted average credit score — and they
didn't see what we called the tails, the tail risk that was in those mortgage
backed securities because data transparency just wasn't that good.
All of the automated
underwriting came in. It all came into new securities. Freddie and Fannie are
racing for market share. They're cutting deals with Countrywide and Wells and WaMu [Washington Mutual] and you name it, to get their
business. It's really leading to lax standards. All of that shit's being pulled
into this big MBS that has a government guarantee on it, which gives it a AAA
rating, which allows it to be marketed globally to any sovereign, because many
sovereigns required AAA only, and they wouldn't invest in PLS [private label
securities], for example, if it didn't have a AAA. That's a whole another story
with the ratings agencies and the non-agency stuff. That's how this whole soup
started getting stirred up.
And, Wall Street — you've
seen the movie — but Wall Street suddenly gets interested. Lou Ranieri, I see
him in the opening of The Big Short, Lou's a pretty good friend. And I don't
think anybody knew what was going to happen downstream. ….He thought you could
create a mortgage backed security and pool loans together, sell them to
investors. Wall Street started saying, “Well, we can get you higher yield by
pooling no doc [documentation] loans, stated income, NINA [no income, no asset]
loans, all this stuff together, this stuff will be 30-year fixed rate also. The
WACs and WALAs, and everything else looked pretty good. And you can buy pieces
of it or you can buy the whole thing. You can buy slices both vertically and
horizontally.” … Likewise, that stuff too had higher rates because they were
considered higher risk. And so, yield chasers could go after that. And then the
tranching of that brought in all the investors at the AB levels. [2]
And this was all happening,
all leading up into an interest rate environment that from 1980 to … 2005 had
dropped from 18% down to single digits. And so the volume [of mortgage
origination] was just extraordinary. 2003 was the largest mortgage origination year
in U.S. history. It was $3.9 trillion. And those refi's [refinances] were
driven by two things. One, this rate rally that had happened over decades and
the extraordinary equity in homes because we hadn't had a market correction
anywhere to speak of in the nation over those decades. And so the ability to do
cash out refinances was outrageous, and second mortgages, and HELOCs [Home
Equity Lines of Credit] built this whole other industry of tapping into equity
— which was done with far riskier underwriting standards — stripped away the
equity that Americans had in their homes. And all of this led us to the
precipice in 2008 when we had equity stripped homes, … excessive debt on too
many Americans because they had, many of them, had been equity stripping and
spending the money they pulled out and then equity stripping again on the next
10% appreciation rate over the next few years. And then layering of risk and
lax credit standards both at the GSEs and the non-agency market.
And the last thing I'll tell
you is, … the defenders of Freddie and Fannie will say, “Well we never, we only
collapsed because they did.” I expect the worst of them will say that we never
should have put been put into conservatorship. The fact is that Freddie and
Fannie both had big portfolios, and they were outside of what we call the flow
business. The front end, the business that I was focused on, was buying 30-year
fixed-rate loans and 15-year fixed-rate loans from banks. Now, more variable
credit terms for volume deals, but the portfolio, which is the other business,
it was essentially a hedge fund that was able to use the AAA wrap given by the
U.S government. So anything Freddie bought or sold came with their lower cost
of capital and … bought it, rewrapped it and sold it, they [investors] could
buy it. They could buy it rich to Freddie and sell it much cheaper back to the
market because it would be wrapped with a AAA bond. We call them off-label
deals.
So, rather than TBA flow —
which is what you call standard 30-year fixed-rate loan — we created things
like T-deals which is an off-label deal. It could have been a pool of pay
option ARMs from Washington Mutual that Freddie would take in on the portfolio
side, wrap it, and sell it out to the market as a T-structure. But that would
end up being triple AAA [rating] by Moody's [Investors Service] and Fitch
[Fitch Ratings Inc.] because it came from Freddie backed ostensibly under the
implicit guarantees provided by the charters of the two institutions.
So what really brought down Freddie – and it
wasn't just pay option ARMs, they were doing, they were buying the sub pieces
and sometimes the A slices on subprime deals and more, so they were helping to
replenish capital to Wall Street. Because Freddie and Fannie were huge buyers
of this stuff on the portfolio side and that actually allowed that business to
get even larger. So, again, there were people saying, “Hey, this is going to
come to an end…[N]o one expected the crisis [of] this entire market — but I
remember multiple conversations like, “When this happens, when there's an
event, we're going to have pockets in this country that are simply way over-extended.”
And again, we had never tested the underwriting standards. Property
appreciation had never been checked because of homebuyer demand driven by low
interest rates and beliefs about wealth generation. It's just the perfect storm
that ultimately led up to this massive collapse, which everybody now can look
back on and say, “Okay, we learned these things.” And whether that sticks going
forward. It's a big question, but yeah, that's essentially the story.
Sean
Nguyen: To switch gears for a moment, you've mentioned
a few minutes ago the affordable housing goals and how they were related or
affected the impact of Freddie's business. Would you be able to speak more to
that?
David
Stevens: Well, Freddie and Fannie both had goals that
were set on them by the regulator. And if you recall, in your research, FHFA
[Federal Housing Finance Agency] their regulator was not as it is today. So
FHFA today is the independent regulator with much greater heft. But back in the
day, the regulator for Freddie sat in HUD [United States Department of Housing
and Urban Development] under the Federal Housing Commissioner. It's hard to
believe, but that's having been the FHA Commissioner, I never had that
regulator, but I was just shocked that that would be the case because they were
unregulated entities.
But nevertheless, one thing
the regulator was responsible for was establishing annual affordable housing
goals upon the two institutions and reporting those to Congress. And the goals
were based on three different factors. One was percent of loans at or below 50%
of median income. The next was at or below – I can't remember – I think it's a
lower percentage. And the third goal was based on targeted census tracts that were
considered underserved, and the GSEs had to get a certain percentage of their
mix of business from those markets. Well, most of it was settled in the below
50% of median income, which, if you're looking at a distribution of mortgages,
you're naturally going to have a big pile of your loans that are below the 50%
median. Even if they're 49%, 48%, north of 46%; it's a big chunk of loans. So
that was one way to achieve those goals. The second way to achieve the goals if
you couldn't buy them as whole loans or through normal securities, is by
offering effectively really good products to help minorities and first time
home buyers and underserved communities get access, which the GSEs both did a
good show to try to do that.
The truth is they never competed with FHA in
that market and they don't today. FHA does the majority of African American, Hispanic,
and first-time home buyers by far over either Freddie or Fannie. And they did
it back then. So to meet the goals, … I remember being called in around
September, October, and we'd suddenly [have] all the senior executives in a
room, and we'd show where we are, we're short. And then we'd go out to Citicorp
and JP Morgan and whoever the hell had a balance sheet and we'd offer a big pay
up because we were printing money in those days, right? Profits were huge
leading up to the Recession. And you say you’d pay anything essentially to get
what you needed. And you go to those banks and … we wanted to look at a cape of
all your mortgages with these parameters, either from these locations or these
income distributions. And they could have already been … securities that were
wrapped by Fannie Mae, and Freddie would look at them and say, “We'll buy that
pool and we'll just rewrap it as a Freddie.” And a lot of that happened, there
was a lot of this purchasing going on towards the year end by both Fannie and
Freddie, just simply to show Congress that they hit the number, when in reality,
they were just double counting because Freddie was wrapping Fannie's and Fannie
was wrapping Freddie's. And it was a little bit of the gamesmanship.
And I continue to harken back
to the point and something that I argue with Mark Calabria even today is:
releasing these entities back to shareholder-owned — out of
conservatorship — companies back under
the auspices of their original congressional charters, in my view, is going to
replicate the entire environment that led them into failure in the first place
because we won’t have changed anything. And I can assure anybody that shareholder
interests will rule the day as time goes on.
And so, it was just a very
interesting period to be sitting there because in the end of the day you have
to hit the affordable housing goals, period. And you're going to do it, even if
you have to pay double for loans that somebody already originated and are
sitting on their balance sheet. It's not like you're creating a new loan,
you're just creating capital relief off of another balance sheet on a loan that
was already created once before. …
Sean Nguyen: … Moving forward a little bit, I
believe that you served as the US Assistant Secretary of the Department of
Housing and Urban Development starting in 2009. Can you describe your official
responsibilities in that role? And what that position entailed during that
time?
David
Stevens: … I was running a big real estate company and I
got contacted about whether I would consider joining the Obama administration.
I went and met with Secretary [Shaun] Donovan. I will tell you, the excitement
of coming to HUD, for me, was not necessarily to run the FHA program day in and
day out. I knew that I wanted to. I knew FHA was in trouble. I testified about
it. If you read my testimony during my confirmation hearing before I was even
in the job, I told the Senate Banking Committee that FHA is in deep trouble and
they're being adversely selected. So I knew what was about to come there, it
just hadn't actually hit until I walked in the door. But we knew that tidal
wave, you could see it, just had to wait until it hit the shores. So I wanted
to focus on that.
And then secondarily, the
President's team was putting together what's called the housing team. And that
consisted of people from: key people from HUD, which I was part of, key people
from Treasury [United States Department of the Treasury], which Tim Geithner
and his team was in charge of, and then folks from the National Economic
Council [NEC], which at the time, Larry Summers, who you may remember,
president of Harvard, was head of the NEC. He led the effort. To me, … the job
of the housing team was to essentially fix the housing crisis anyway we could
and come up with as many solutions as possible – when we were implementing HAMP
[Home Affordable Modification Program] and had all the big services coming in
periodically and that kind of thing. That was spearheaded by Larry [Summers]
and Tim [Geithner].
Anyway, so my
responsibilities at FHA officially were, I was a US Assistant Secretary of
Housing and Federal Housing Commissioner. It's the number three job at HUD
after the [Deputy Secretary], and the Secretary, of course. It has the majority
of the employees at HUD, and we're responsible for the single-family lending
business. We were, at the time: the single family lending business, insurance
business, multifamily, and hospitals and nursing homes. And then on top of it,
I had the Office of Regulatory Affairs [Office of Risk Management and
Regulatory Affairs]. Much of that has been dissected post-Dodd-Frank [the
Dodd–Frank Wall Street Reform and Consumer Protection Act] and moved over to
CFPB [the Consumer Financial Protection Bureau]. But we did RESPA [Real Estate
Settlement Procedures Act] and HMDA [Home Mortgage Disclosure Act] and things
of that sort that came out at the time. But again, the primary mission
obviously was — HUD had a very different focus from the GSE's. We're [HUD] not
shareholder owned, but government owned. People felt a mission to help
communities. So much of our work and the audiences that we dealt with were
touring low-income apartments in hard-hit sections of Denver, flying to New
Orleans with the Secretary and all of us to spend several days looking at some
of the hardest hit areas after the floods that occurred there, and trying to
help support recovery of those areas. …
I'll narrow into two areas of
focus. One was I knew FHA was being adversely selected, and it's largely
because after the collapse of the subprime business, FHA never had a credit
score floor. You could originate I think down to 400. And if you look at loans
that were originated — it's all public on their website, you have to go back
and go through their data — but loans originated in 2007 and 2008 and 2009,
there was a significant surge in loans under 500 credit scores, let alone 500
to 600, all of which are disastrous credit scores. But when the subprime
industry collapsed, a lot of the originators flocked [to] companies that
allowed them to come in and started originating some really bad stuff. And so
we knew that expected defaults were going to fly through the roof.
FHA was also being impacted
because of one product, the reverse mortgage program, and another product
called seller funded down payment assistance. Those two loans, the seller
funded down payment assistance, was a congressionally authorized product that
allowed sellers to finance the down payment, which really not did nothing more
than result in inflated home prices that made people have to live underwater in
their homes, no matter what happened. And they had 30-ish% default rates. That
[seller funded down payment assistance] expired in 2009, but we were stuck with
that portfolio. And then the reverse mortgage program got moved from another
fund called the GISRI [General Insurance and Special Risk Insurance] fund that
handles multifamily into single-family, and the reverse mortgage program has
just a multitude of problems – still does to this day — and has whipsawed the
value of that fund around.
So, we had all these defaults
coming in from the reverse [mortgage] program. We had huge problems with HECMs
[Home Equity Conversion Mortgage], with technical defaults going on there, that
still no one's ever really written a story on. And then, we had a ton of
lenders doing really bad things by originating really bad loans. So I think in
my first year and a half there, they self-terminated something like 1,100
lenders out of the program. And I chaired what's called the Mortgagee Review
Board, and we would meet every month and review a whole slew of cases of
lenders that had violated the guidelines and we'd either exact penalties or
terminate them. Shaun Donovan once called me “Sheriff Dave….”
But, they really screwed up. We changed the
underwriting standards. We put in a FICO [score] minimum. And there's some
challenges to that because wherever you draw that line, it’s going to
ultimately impact primarily minority borrowers because FICO distributions are
not the same in African American communities, as they are white, non-Hispanic.
So this was all data-driven, but we ultimately put in a 580 FICO floor, instead
of having it go down to 400. And even there, there's a lot of risk, but most
lenders even self-corrected by putting minimum [FICO scores] floors of their
own at 620 to 640, so that problem got solved.
And then the other side of it
was the meetings, which really became the majority of my time, was meeting with
Tim Geithner, who led the effort on a day-to-day basis. And a team of about
eight of us who met three to four days a week. Just focused solely on what do
we do, what other solutions can we present to the President in order to help
stem the collapse, because on all of this, the goals here during that period
was to stop the bleeding, stop the downward spiral. That was number one. Number
two was to protect as many homeowners as we could without creating moral
hazard, which is a very difficult thing in policymaking. And that's why it
didn't become a giveaway, even though that was discussed. And then third, was
to implement a whole series of new rules and promote the Dodd-Frank legislation
and more to help make sure this never happens again. And those were the three
missions outside of my day to day job that I participated in, with obviously, a
very interrelated team out of the White House, Treasury, and HUD.
Sean
Nguyen: We have two more questions for you, David, and
we're approaching the close of our interview. How would you say your experience
in the private sector informed your perspective when in positions of leadership
during your time in the public sector?
David
Stevens: Well, look, I will tell you — and by the way,
this is anybody who was in the business like I was — we all made mistakes in
the private sector. We all were active participants in the business as it
evolved to what ultimately led to the precipice. So, none of us, me included,
could claim innocence.
But, I knew, walking into the
door at HUD, more about how the primary market and the GSE market operated. I
knew more about how that market worked than anybody in the administration. And
I literally remember a meeting — at that time I would meet with the President
fairly frequently, which was rare for an FHA commissioner — but we met about
every three weeks because we were in the midst of what we were in. I remember
one meeting I couldn't be there and they changed the meeting. And — short
anecdote — my very first meeting with the President, I remember texting my
wife. At the time, you could bring in cell phones, now you can't bring them
into the Roosevelt room in the White House. But, I remember walking in the room
and everybody's got a master's or PhD from Harvard [University] or Yale
[University]. And I'm walking with my BA in political science, which I barely
got because I skied too much. I thought it was absurd and I was literally going
to sit in the back couches in the Roosevelt room. And it was Geithner who
looked at me, and goes, “You're Stevens, right?” I said, “Yeah.” And he goes,
“I want you at the table.” So besides the table, the President walks in, and he
always had read everything. He was very knowledgeable — unlike the current guy
— and he said, “Look, I've read all the information. I just have one question:
Can someone explain what a warehouse line is?” And at the time, back in early
2009, mid 2009, the administration was contemplating using remaining TARP
[Troubled Asset Relief Program] funds to create a warehouse lending facility
because for people to fund mortgages, they needed short term lines of credit
and that had all dried up. And so, the table goes silent and Tim [Geithner]
looks down to me at the end of the table and says, “Stevens, answer the question.”
So I start explaining what a
warehouse line is, which to me seemed like how to ride a tricycle, and no one
else is understanding. No one else really could explain what it is. If they had
understood it was a short-term credit facility, or we talk about a repo line
[repurchase line], the Wall Street guys could've talked about it in that
context. They had never heard the term warehouse line. So I started explaining
it to the President and I look up and I see the President of the United States,
who at time was sort of my hero, staring at me. So here's this rookie — unlike
you guys who are getting your MPPs [Master of Public Policy] or whatever the
hell you're getting in your academic pedigree — I was just the school of hard
knocks, but I became extremely invaluable to the point where Tim would always
want me in the room. Larry Summers would always want me in the room because I
knew how the business ran. So if they're coming up with some crazy idea that
they're going to get banks to do, I could say, “There's no effing way that's
going to happen.”
So that, that became
essentially my role for that period. And I ended when the midterm elections
came and the Tea Party took over… in 2011, I knew nothing more was going to be
done. And a lot of people were dropping like flies. I left, Geithner
left, Diana Farrell, who is the player in the White House who really ran
everything for Larry Summers, left. I mean, we started seeing these folks
walking away at the midterm mark. And so I was never going to be a government
guy, and I certainly didn't want to sit around and just run FHA for two more
years. So I decided to exit the building.
Sean
Nguyen: What extent do you see your personal experience
as adding something to our project’s understanding of what happened in the run-up
of 2007 to 2008?
David
Stevens: Trust but verify. Always anticipate what could
go wrong. It's interesting because this wasn't a bunch of ignorant people,
right? You had Kings of Wall Street. This powerhouse that built Lehman
[Brothers Holdings Inc.], and Bear [Sterns Companies, Inc.], DLJ [Donaldson,
Lufkin, & Jerette]. All these guys on Wall Street, you had mega banks.
Wachovia bought Golden West [Financial] for 30-something billion dollars, only
ultimately to completely collapse and be taken over by [Wells Fargo]. Nobody
saw what was coming. And I think a lot of that was because the pace of change,
the introduction of technology, the uncorrected, untested real estate market in
the United States created a euphoria that made people believe you can do no
wrong.
And, Elizabeth Warren, who
I've gotten to know very well, I have handwritten notes from her on my office
wall because we've had a very good relationship.. . . “Why hasn't anybody gone
to jail?” has always been one of her mantras. And I think the reason is, nobody
— very few, at least, I mean [Lee] Farkas, there's few guys who are in jail
right now — but very few people really committed a crime. It was a massive set
of ignorant actions, not recognizing that creating false assumptions based on
untested models that, ultimately, upon testing proved to be the biggest single
failure in the US economy since the Great Depression. I see some of it now,
quite frankly.
This shortage of inventory in
the real estate market is creating unprecedented appreciation because of supply
and demand stress. And I think home prices are just inflating well beyond what
they should be, if we were developing a supply chain that made sense. There's a
whole new growth of non-QM [Qualified Mortgage] lenders. … It's the qualified
mortgage rule that everybody else abides by, including the GSEs for the most
part. There's a whole bunch of quote unquote, non-QM lenders, bringing back
ways to do stated income using bank statements and things of that sort. It's in
its infancy, but there's got to be warning signs.
The other thing I would just
say to you guys is you need strong regulators. Freddie and Fannie's regulator
was weak. There was really no regulator overseeing the Wall Street expansion
that had any heft. It was the SEC, I guess. So there, there was really nothing
there. The attacks on the CFPB by the conservatives, to me, worries me. I think
you need someone who's literally considered by the lending community as a pain
in the ass. I think Rich Cordray was an extremely invaluable part of the
housing finance system. [Joseph Smith, Former North Carolina Commissioner of
Banks] down in North Carolina who I think referred me to you, played a big
role. You need folks like that, that bring an independent oversight with heft,
with power, with the ability to stop the train. And that just didn't exist.
State regulators didn't do
their job. Federal regulators didn't do their job. They let Wall Street grow
out of proportion and bank executives and GSEs were spending hundreds of
millions of dollars collectively on their lobbyists. And to paper the campaigns
and payrolls backside — not payrolls in an illegal sense — but the fundraising
efforts of members of Congress. Wall Street can buy politics and you need to
have civic leaders who have backbone and understand the business and will stop
it when they see it's coming. And we didn't have it then. Even the head of the
Federal Reserve, I was in a car with the CEO of Freddie Mac one day and he
said, “I got to make a call.” And he was on the phone with [Alan] Greenspan and
they were like buddies. Literally, everyone was at fault for what happened
here.
By the way, homeowners were
too, but you can't blame them per se, because they were convinced. If the
lender says I can borrow the money, I'm sure I can borrow it. But I do believe
the hindsight right now is, we've got to keep that rear-view mirror front and
center in front of every decision maker, executive finance executive. I think
finance leaders should have an obligation to go through an annual risk
evaluation. It should be a required reading to constantly look back at this
period and compare what you're doing now to what happened then because the goal
for profits and the power of some of the largest financial institutions is
going to trump the regulatory framework, because we tend to create crisis
regulatory environments, which is what happened post-recession. And that will
weaken over time, especially as we go through a period of continued
improvement.
Under the Republican
administration — not to be partisan, but I'm going to be — this desire to weaken
regulation, to allow the private sector to do its thing cause that's better for
the economy. I just think that's ultimately shortsighted in this system. It's
too easy to make mistakes and there's too much at risk.
[END OF SESSION]