Meet Marion and Herb Sandler. They’re good people, you’ll like them. As two of the most prolific and committed philanthropists currently supporting progressive causes, they are currently major funders of ProPublica (investigative journalism), the Centre for American Progress (activism), the Centre for Responsible Lending (anti- payday loans, financial fairness) and the American Asthma Foundation. The contribution of US$1.3bn that they gave to the Sandler Foundation was the second largest charitable contribution of 2006, according to Wikipedia. They are a bit too keen on testing and measurement in education for my taste but you can’t have everything, and they are at least advocates of “multiple measures”.
Meet the Pick-A-Pay Option ARM. This was a lending product that, among other features, allowed for “negative amortization” – a feature under which the principal was not repaid but rather rolled up, meaning that the borrower was effectively dependent on future refinancing. It was not a subprime product, but it allowed people to take on huge amounts of mortgage debt, and contributed to the “payment shock” which sent so many of them into repossession and bankruptcy. As the link above shows, the Pick-A-Pay mortgage product was the subject of a number of compensation settlements with affected borrowers.
What’s the connection? Well, as founders of Golden West Financial, a mortgage lender which was sold to Wachovia Bank in 2006 (the proceeds of which financed that very large charitable contribution), Herb and Marion Sandler were responsible for introducing the Pick-A-Pay mortgage to the market.
Read on, there’s two or three more twists before the end of this story …
Obviously, this looks like it might be political gold for anyone wanting to do an “oh my god those hypocritical liberals” story. Which is more or less what Sixty Minutes did two and a half years ago, relying heavily on whistleblower testimony from a loan salesman who characterized Golden West (trading under the name “World Savings Bank”) as “sitting on an Enron”, and “granting people too many loans who simply didn’t qualify”. They interviewed a borrower called Betty Townes who had taken out sequential Pick-A-Pay mortgages, refinancing their way into a mountain of debt and inevitable bankruptcy when the cycle turned.
Except that …
Well, it turned out that the whistleblower in question had in fact been sacked for persistent incompetence and rudeness, and had his case thrown out of arbitration with an award of zero. Not very much of the rest of the story (or similar hatchet jobs in the New York Times and elsewhere) held up either. In fact, Golden West had always been almost parodically careful as a lender, carrying out far more due diligence and credit checks on their borrowers than most other banks. They also eschewed most of the aggressive marketing practices of the industry, and rather than securitizing their mortgages, they kept them on their own balance sheet. And the Sandlers for the most part managed to get apologies and at least part retractions from most of the media outlets that ran these stories. Even five years later, the pre-2007 vintages of Pick-A-Pay have performed vastly better than the ones which Wachovia (later taken over by Wells Fargo) continued to write in 2007 and 2008 under the same brand name.
So, it turns out that the doyens of the progressive funding sphere were also extremely careful, cautious and ethical bankers. If only everyone were so good.
Except that …
Except that well, do you remember Betty Townes from a few paragraphs ago? She was a real person, and what she said happened to her, did. And although I called the New York Times article on the Sandlers a “hatchet job” two paragraphs ago, and the NYT did make some changes to it (most prominently, changing the headline from “Once Mortgage Pioneers, Now Pariahs”), the newspaper basically stands by its reporting of all the factual claims made. And, although the performance of pre-07 Pick-A-Pays is definitely better than other option-ARMs out there, that still leaves room for them to be pretty bad.
What it shows is that a combination of the best will in the world, the most cautious and conservative funding structure and an utterly exemplary set of lending practices, will still leave you writing a whole lot of crap and causing huge amounts of suffering if there is a once in a lifetime asset price bubble going on. As I believe I have said both here and on my own blog, big macroeconomic problems like the US housing bubble and recession have macroeconomic causes, not microeconomic ones. And that’s an end to it.
Or is it?
Well, not quite. It should be noted that, although Herb Sandler vehemently denies having sold out in 2006 in order to cash out at the top of the market (ie, he does not claim to have had any foresight about the crash), 2006 was the cusp year; the year during which house prices, particularly in the Californian market where Golden West did the majority of its business. After the takeover (and things are complicated somewhat by the existence of an interregnum, when Sandler remained in charge of the business under new ownership), Wachovia started to write option-ARM business that couldn’t possibly have been justified under the Sandlers’ business practices. An awful lot of bankruptcy-creating, repossession-generating, outright bad business was done during this period and it has certainly contributed a lot of really bad securities to the market, helping to spread the contagion of the financial crisis, and contributed much more than its fair share to the overhang of foreclosures. It ought to be a sensible goal of regulation to prevent this sort of thing, and it could do so by helping to ensure that future mortgage banking is more like Golden West. And yes (oh god it kills me to admit this), that regulation would have to work by condign punishment of people who committed lending practices like those observed in the California market in 2007 and 2008, many of which were outright fraudulent. Are you happy now?
Well you shouldn’t be.
By definition, anything that was done in 2007 or 2008 isn’t really a “cause of the crisis”. The contagious financial panic of 2008 was, in fact, largely contained thanks to the prompt activity of the Federal Reserve (in America anyway, in Europe we have problems of our own). The USA is in a recession now because of a massive disappearance of housing wealth, not anything else. And the disappearance of housing wealth was due to the bubble built up before 2006, not in 07-08.
With the best will in the world, as I say, if there is a massive imbalance in the real economy (in this case, the decision to accommodate Chinese exchange rate policy and run a consequent current account deficit), there will be a similar imbalance in the financial sector which intermediates it (in this case, equilibrates the resulting capital flows). And doubly so if the official policy of the central bank at the time is to create a housing market boom, and the official anti-bubble policy of the central bank is to allow the bubble to grow, on a promise that action will be taken to mitigate the consequences when it pops. Although it’s had all sorts of twists and turns, at the end of this story, I’m not judging the main characters to be either heroes or villains, because economics isn’t a morality tale.