Transcript

355:

The Giant Pool of Money
Transcript

Originally aired 05.09.2008

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Full audio: http://tal.fm/355

Prologue.

Ira Glass

So Adam, where are we?

Adam Davidson

I recorded this at the Ritz Carlton in Lower Manhattan. It's a black tie dinner. It was just a few weeks ago.

Ira Glass

And you, by the way, are NPR's international business and economics correspondent?

Adam Davidson

That's right. I was there for my job. They're giving out awards for all these financial securities, including the one that nearly brought down the global financial system in the whole sub-prime mortgage crisis.

Dinner Mc

At this time, I'd like to ask all of our stars to please assemble over here on the left side of the stage--

Jim Finkel

This guy is a legend. He's a granddaddy of our industry.

Adam Davidson

I'm sitting at this dinner with Jim Finkel. He's kind of nervous, because he's up for CDO of the year for the CDO he created, Monterey. Now, the CDO, that's what we're talking about. That's the financial instrument that was central to this global credit crisis we're in.

Ira Glass

And they gave awards for this? These guys are giving each other awards for doing that?

Adam Davidson

Let me just say that they were aware that there's a certain irony, giving awards to the instrument that almost destroyed the world economy. And they did consider canceling this year. But it's been a really tough year. It's been really gloomy for them.

Jim Finkel

Honestly, I know this sounds-- I was really happy to see there were no major suicides, people weren't jumping off bridges, there weren't a lot of personal disasters.

Adam Davidson

Now that same week, a few days earlier, across the river in Brooklyn, I went to a completely different kind of gathering. It was not black tie. It was put on by the Neighborhood Assistance Corporation of America. It was people on the opposite side of the mortgage crisis, people facing foreclosure, trying to figure out how to keep their homes.

I met this one guy, Richard. He's a marine. He's this big guy, over six feet tall. And when he came back from Iraq a few years ago, he bought one of these fancy new mortgages with an adjustable rate. Recently his rate reset. It has gone up by more than $2,000 a month. And he has fallen behind on his payments.

Richard

It got to the point where-- one point, my son had $7,000 in a CD. And I had to break it. And I mean that really hurt, because I was saving that money for his college. I mean, I put $2,000 back. But it's like you can't have a future. They put you in a situation where, after a while, you're going to fail. It's hard.

Adam Davidson

Now, it's clear that these two groups are connected, Jim at his black tie dinner and Richard the marine. The sub-prime crisis has connected them.

Ira Glass

Right, and I know that, basically, this is what sent you and one of the producers of our show, Alex Blumberg, on a big reporting mission these past few months. You saw that, that there is this long chain of people that starts with these Wall Street guys and ends with people who stand to lose their houses. And all along that chain there were bankers, and brokers, and investors, and homeowners. And everybody along the chain kind of deluded themselves, thinking they could throw out the old rules of banking.

Adam Davidson

Right, in all the coverage of this, we hadn't heard that much from the people all along the chain. We wanted to know, what were they thinking when they were doing all this? And why did they think it would work? And simply, how did it all work?

Ira Glass

So, this is what we're devoting our program to today. From WBEZ Chicago, it's This American Life, distributed by Public Radio International. I'm Ira Glass. And today's show is a special co-production we're doing with NPR News, your place of employment, Adam.

Adam Davidson

Very proudly so.

Ira Glass

You and Alex Blumberg are going to be explaining step-by-step how this all worked. And we will meet some of the people who created this economic disaster. And so let me turn the show over to the two of you, which is great for me, because I've pretty much lost my voice anyway. And Alex Blumberg will kick things off.

Act One.

Alex Blumberg

The thing that got me interested in all this was something called a NINA loan. Back when the housing crisis was still a housing bubble, a guy on the phone told me that a NINA loan stands for no income no asset. As in, someone will lend you a bunch of money without first checking to see if you have any income or any assets.

And it was an official loan product, like you could walk into a mortgage broker's office and they would say, well, we can give you a 30 year fixed rate, or we could put you in a NINA. He said there were lots of loans like this, where the bank didn't actually check your income, which I found confusing.

And it turns out even the people who got them found them confusing. For example, a guy I met named Clarence Nathan. He worked three part-time, not very steady jobs, and made a total of $45,000 a year, roughly. He got himself into trouble and needed money. So he took out a loan against his house, a big one.

Clarence Nathan

Call it $540,000 for round figures.

Alex Blumberg

You basically borrowed $540,000 from the bank, and they didn't check your income?

Clarence Nathan

It's a no income verification loan. They don't call me up and say, how much money? They don't do that. I mean it's almost like you pass a guy in the street, and you say, will you lend me $540,000? He says, well what do you do? Hey, I got a job. OK.

It seems as if it's that casual, even though there are a lot of papers that get filled out and stuff flies all over with the faxes and the emails, and all like that. Essentially, that's the process.

Alex Blumberg

Would you have loaned you the money?

Clarence Nathan

I wouldn't have loaned me the money. And nobody that I know would have loaned me the money. I mean, I know guys who are criminals that wouldn't lend me that money, and they'd break your kneecaps. So [LAUGHING] yeah, I don't know why the bank did it. I'm serious. $540,000, a person with bad credit.

Alex Blumberg

As it turns out, Clarence's friends, acquaintances and shadowy criminal contacts would have been right not to lend him the money. By the time I talked to him, Clarence hadn't made a payment in almost a year, and his house was in the process of foreclosure.

And stories like this have been in the news for months. And they often feature an innocent homeowner who was duped by a lying, greedy mortgage banker. Or if you're more of a Wall Street Journal editorial page type, an innocent mortgage banker who was duped by lying, greedy homeowner. And no doubt, both categories exist. But Clarence's case is more nuanced, and much more common.

Clarence Nathan

Nobody came and told me a lie, and told me a story, and said, oh, just close your eyes, and all your problems will go away. That wasn't the situation. The situation was that I needed the money. And I'm not trying to absolve myself of anything.

I had a situation. And I thought that I could do this, and then get out of it within six to nine months. The six to nine month plan didn't work, so I'm stuck. But if somebody had told me, you couldn't borrow the money, I probably would have had to do something else more drastic and dramatic, and not be in this situation now. The bank made an imprudent loan. I made an imprudent loan. So the bank and I are partners in this deal.

Alex Blumberg

This imprudent partnership is new. And it's at the heart of the current housing crisis. For most of the history of banking, bankers wouldn't have loaned Clarence their money either. They didn't let people like Clarence near their money, in fact, people with part time employment and unpaid debts in their past.

And then suddenly in the early 2000s, everything changed. Banking turned on its head and went out looking for partnerships with people like Clarence, loaning him half a million dollars without even checking to see if he had a job. What happened? Well to help explain what happened here is my partner for the hour, Adam Davidson, the international business reporter for NPR. Hey, Adam.

Adam Davidson

Hey, Alex.

Alex Blumberg

How's it going?

Adam Davidson

Good.

Alex Blumberg

I got your title right, right?

Adam Davidson

Yes. Well, not exactly.

Alex Blumberg

Oh, what is it?

Adam Davidson

It's international business and economics correspondent, actually.

Alex Blumberg

Oh, sorry. It actually sounds more impressive. OK, so I guess the first thing we have to do is talk about the global pool of money, right?

Adam Davidson

Right, the global pool of money, that's where our story begins. Most people don't think about it, but there's this huge pool of money out there, which is basically all the money the world is saving now-- insurance companies saving for a catastrophe, pension funds saving money for retirement, the Central Bank of England saving for whatever central banks save for, all the world's savings.

Ceyla Pazarbasioglu

A lot of money, it's about 70 trillion.

Adam Davidson

That's the head of capital market research at the International Monetary Fund, the place to go if you want to figure out how much money is in the world. So first off, how do we pronounce your name?

Ceyla Pazarbasioglu

That will probably take, if this goes on air, probably, that will take two minutes at least. It's Pazarbasioglu, Ceyla Pazarbasioglu.

Adam Davidson

Ceyla Pazarbasioglu.

Ceyla Pazarbasioglu

I'm very impressed.

Adam Davidson

And by the way, before you finance enthusiasts start writing any letters, we do know that $70 trillion technically refers to that subset of global savings called fixed income securities. Everyone else can just ignore what I just said. Let's put $70 trillion in perspective. Do this. Think about all the money that people spend everywhere in the world, everything you bought in the last year, all of it. Then add everything Bill Gates bought, and all the rice sold in China, and that fleet of planes Boeing just sold to South Korea, all the money spent in every country on Earth in a year. That is less than $70 trillion, less than the global pool of money.

Alex Blumberg

Wow.

Adam Davidson

We're talking about a lot of money.

Alex Blumberg

That is a lot of money.

Adam Davidson

And that money comes along with armies of very nervous men and women watching over the pool of money. Investment managers, they don't want to lose a penny of that. They don't want to lose any of that money, and, even more so, they want to make it grow bigger. But to make it grow, they have to find something to invest in.

So, most of modern history, what they did was they bought really safe and, frankly, really boring investments like treasuries and municipal bonds, boring things. But then, right before our story starts, something changed, something happened to that global pool of money.

Ceyla Pazarbasioglu

This number doubled since 2000. In 2000 this was about $36 trillion.

Adam Davidson

So it took several hundred years for the world to get to $36 trillion. And then it took six years to get another $36 trillion.

Ceyla Pazarbasioglu

Yeah, there has been a very sharp increase.

Adam Davidson

How does the world get twice as much money to invest? There are lots of things that happen. But the main headline is that all sorts of poor countries became kind of rich, making things like TVs and selling us oil. China, India, Abu Dhabi, Saudi Arabia made a lot of money and banked it.

China, for example, has over a $1 trillion in its central bank. And there are office buildings in Beijing filled with math geniuses, real math geniuses, looking for a place to invest it. And the world was not ready for all this new money. There is twice as much money looking for investments, but there are not twice as many good investments.

So that global army of investment managers was hungrier and twitchier than ever before. They all wanted the same thing, a nice, low-risk investment that paid some return. But then something happened that makes matters worse. At this precise moment, one guy took one of that army's favorite investments and made it a lot less attractive.

Alex Blumberg

This is where we have to talk about Alan Greenspan, right?

Adam Davidson

Yeah, we have to.

Alex Blumberg

All right. But I'm just going to promise people that is the only time you're going to hear Alan Greenspan in this story. So bear with us.

Adam Davidson

All right. Here's one of his speeches that really drove that army of investment managers crazy.

Alan Greenspan

The FOMC stands prepared to maintain a highly accommodative stance of policy for as long as needed to promote satisfactory economic performance.

Adam Davidson

You might not believe me, but that little statement, that is central banker's speak for, hey, global pool of money, screw you.

Alex Blumberg

Come on, that's not what he said.

Adam Davidson

It is. I speak central banker. Believe me, that's what he said. What he is technically saying is he's going to keep the fed funds rate-- that's when you hear, the fed interest rate-- at the absurdly low level of 1%.

And that sends a message to every investor in the world, you are not going to make any money at all on US Treasury bonds for a very long time. Go somewhere else. We can't help you.

And so the global pool of money-- which does speak central banker. They understood what he was saying-- they looked around for some low-risk high-return investment. And among the many things they put their money into, there was this one thing that they fell in love with. To get it, they called Wall Street, a guy like this.

Mike Francis

My name is Mike Francis. During the beginning of the mortgage implosion, I was an employee, executive director at Morgan Stanley on the residential mortgage trading desk.

Adam Davidson

Mike was one link in a chain that connected the global pool of money to its new favorite investment, residential mortgages, the US housing market, and guys like Clarence Nathan. Think how attractive a mortgage loan is to that $70 trillion pool of money.

Remember, they're desperate to get any kind of interest return. They want to beat that miserable 1% interest Greenspan is offering them. And here are these homeowners paying 5%, 9% to borrow money from some bank. So what if the global pool could get in on that action?

There are problems. Individual mortgages are too big a hassle for the global pool of money. They don't want to get mixed up with actual people, and their catastrophic health problems, and their divorces, and all the reasons that might stop them from paying their mortgages. So what Mike and his peers on Wall Street did, was to figure out a way to give the global pool of money all the benefits of a mortgage-- basically higher yield-- without all the hassle and risk.

So picture the whole chain. You have Clarence. He gets a mortgage from a broker. The broker sells the mortgage to a small bank. The small bank sells the mortgage to a guy like Mike at a big investment firm on Wall Street. Then Mike takes a few thousand mortgages he's bought this way, he puts them in one big pile.

Now he's got thousands of mortgage checks coming to him every month. It's a huge monthly stream of money, which is expected to come in for the next 30 years, the life of a mortgage. And he then sells shares of that monthly income to investors. Those shares are called mortgage-backed securities. And the $70 trillion global pool of money loved them.

Mike Francis

It was unbelievable. I mean, we almost couldn't produce enough to keep the appetite of our investors happy. More people wanted bonds than we could actually produce. That was our difficult task, was trying to produce enough.

They would call and say, we're looking for more fixed rate. What have you got? Do you have anything coming? What's going on? Tell us what you're trying to do. From our standpoint, it's like, there's a guy out there with a lot of money. And we have got to find a way to become his sole provider of bonds, of mortgage bonds, to fill his appetite. And his appetite's massive.

Alex Blumberg

The problem was, to make a mortgage-backed security, you needed mortgages. Lots of them. So for Mike Francis to satisfy this demand and take his quite hefty fee from the global pool of money, he needed to buy up as many mortgages as possible.

And to do that, he called a guy one link below him on this mortgage-backed security chain, a guy named Mike Garner, who worked at the largest private mortgage bank in Nevada, called Silver State Mortgage. And to give you a sense of how fast this business was growing, Mike Garner got into the mortgage business straight from his previous job as a bartender.

Mike Garner

One of my regulars, he actually hired me from the bar. He just said he needed some guys, and if I was interested in working for him. And then we started talking about how much I made and that. He beat me. He beat what I was making, so. I didn't know anything about the mortgage business. I was as green as you could be.

Alex Blumberg

Mike Garner's job-- the guy in Nevada-- was to buy up individual mortgages, mainly from brokers, bundle 200 or 300 of them together, and then sell them up the chain to Wall Street, to guys like Mike Francis.

Adam Davidson

There's just too many Mikes here.

Alex Blumberg

I know. So many Mikes. There is actually just two Mikes. There's Mike Francis, the guy on Wall Street, and Mike Garner, the guy we're talking about now.

Adam Davidson

He's in Nevada.

Alex Blumberg

He's in Nevada. Right. And in the beginning, he'd only buy mortgages that were pretty standard and pretty safe. Mortgages where people had come up with a down payment and proven that they had a steady income and money in the bank. And they sold so many of these mortgages that there came a point in 2003 where just about everybody who wanted a mortgage and was qualified to get one, had gotten one.

But the pool of money had just gotten started. They wanted more mortgage-backed securities. So Wall Street had to find more people to take out mortgages, which meant lending to people who never would have qualified before. And so Mike Garner in Nevada noticed that every month the guidelines were getting a little looser.

Something called a stated income verified asset loan came out, which meant that people didn't have to provide a paycheck stub or W-2 form to get a loan as they had in the past. They could simply state their income, as long as they showed that they had money in the bank.

Mike Garner

The next guideline lower is just stated income, stated assets. That came out. So then you basically state what you make, and then you state what's in your bank account. They call and make sure that you work where you say you work. And then an accountant has to say that for your field, it is possible to make what you say you make. But they don't have to-- they don't say what you make. They just say, it's possible that he could make that.

Alex Blumberg

If you could stop there for one second, it's just so funny that instead of just asking the people to prove what they make, there is this sort of theater in place of like, you have to find an accountant to say, yes this person who is sitting right in front of me, and who could very easily provide a W-2 form-- but we're not asking for a W2 form-- but we do want this accountant to say that, yeah, that person, what they're saying is possible in some universe.

Mike Garner

And I mean, loan officers would have an accountant that they could call up and say, can you write a statement saying that a truck driver can make this much money, or whatever.

Then the next one came along. And it was no income verified asset. So you don't have to tell the people what you do for a living. You don't have to tell the people what you do for work. All you have to do is state that you have a certain amount of money in your bank account. And then the next one that came out is just no income no asset. So you don't have to state anything. You just have to have a credit score and a pulse.

Alex Blumberg

Actually that pulse thing, also optional, like this case in Ohio, where 23 dead people were approved for mortgages.

Adam Davidson

An interesting fact here. Mike Garner's bank did not care all that much how risky these mortgages were. This was a new era. Banks did not have to hold on to these mortgages for 30 years like they used to. They didn't have to wait and see if they'd be paid back. Banks like Garner's would just own the mortgages for a month or two. And then they sold them on to Wall Street. And then Wall Street would sell them on to the global pool of money.

Alex Blumberg

Which is how we get half million dollar no income no asset loans.

Adam Davidson

--and loans to dead people. So there's this whole other thing going on as well. Housing prices were rising fast. I think we all remember that. Lots of people in the mortgage industry had this faith that housing prices in the US simply never go down.

So from the bank's perspective, even if the worst happens and someone defaults, the bank would then own a house, which is now worth even more than what they gave out in the loan. So all Mike cared about was whether or not his customers, the Wall Street investment banks, would buy those mortgages from him.

And he was under pressure to approve more and more loans. Because other guys in his company-- the actual guys cruising strip malls all across Nevada buying mortgages from brokers-- their commission depended on selling more loans. And occasionally those guys would hear about some loan that some other mortgage company offered that they weren't allowed to offer. And they'd complain to Mike.

Mike Garner

Three of them would show up at your door first thing in the morning, and say, I lost 10 deals last week to Meritius Bank. And they've got this loan. Look at the guidelines for this loan. Is there any way we can do this, because we're losing deals left and right?

Either they would find out who they were selling it to, or I'd get on the phone and start calling all these street firms or Countrywide and say, would you buy this loan? And finally, you'd find out who's actually buying them and would say, yes.

Alex Blumberg

So like, Merrill Lynch would say no, and Goldman Sachs would say no, and then you'd finally hit on somebody, and they would be like, yeah, we'll buy that loan.

Mike Garner

Yeah, and then once I got a hit, then I'd call the other people back and say, listen, Bear Stearns is buying this loan. And I would like to give you the opportunity to buy these loans too. And once one person buys them, usually all the rest follow suit.

Alex Blumberg

So, what were you thinking when you're turning around, and you're selling those to Wall Street? Were you ever thinking to yourself like, what are you guys doing?

Mike Garner

Yeah, and my boss had been in the business for 25 years. And he hated those loans. He hated them. And he used to rant and just say, it makes me sick to my stomach the kind of loans that we do. And he fought the owners and the sales force, tooth and neck, about these guidelines. And we got the same answer every time. Nope. Other people are offering it. We're going to offer it too. We're going to get more market share this way. House prices are booming. Everything's going to be good. And the company was just rolling in the cash. I mean, the owners and the production staff were just raking it in.

Glen Pizzolorusso

At the height, I was making between $75,000 and $100,000 a month.

Alex Blumberg

This is Glen Pizzolorusso, who was an area sales manager at an outfit called WMC Mortgage in upstate New York. And just to repeat, he said $75,000 to a $100,000 a month. That's over a $1 million a year. Glen was just out of college. His job was a lot like Mike Garner's. He's the same link in the chain. And Glen loved his job.

Glen Pizzolorusso

What was that movie, Boiler Room? Did you ever see that movie? That's what it was like. I mean, it was the coolest thing ever. Just cubicle, cubicle, cubicle for 150,000 square feet. The ceilings were probably 25, 30 feet ceilings. The elevator had this big graffiti painting on it that was awesome.

Alex Blumberg

A graffiti painting, meaning like, that had been there since before you guys moved in? So they had not done any amenities to this place?

Glen Pizzolorusso

No, it was just a big, open space. And it was awesome. We lived mortgage. That's what we did. That's all we did. All of us, we just lived it. This deal, that deal, what's going on here? How are we going to get this one funded? What's the problem with this one? I mean, you get there, and that's all everybody is talking about.

Alex Blumberg

And when Glenn wasn't working, he was doing his next favorite thing, spending, preferably, in the company of-- and this is his term-- B-list celebrities.

Glen Pizzolorusso

We would roll up to Marquee at midnight, with a line 500 people deep out front. Walk right up to the door. Give me my table. We're sitting next to Tara Reid and a couple of her friends. Christina Aguilera was doing a-- whatever, I'm Christina Aguilera. I'm going to get up and sing. So Christina Aguilera and all her people are there.

Who else was there? Cuba Gooding and that kid from Filthy Rich: Cattle Drive. What was that kid's name? Fabian [? Barabia. ?] We ordered, probably, three or four bottles of Cristal at $1,000 a bottle. They bring it out. They are walking through the crowd. They hold the bottles over their head. There is fire crackers and sparklers. The little cocktail waitresses, so you order four bottles of those, they're walking through the crowd of people. Everybody is like, whoa, who's the cool guys? Well, we were the cool guys. You know what I mean? They gave me a black card. This little card with my name on it. There's probably like 10 of them in existence. And that meant that I just spent way too much money there.

Alex Blumberg

Glen had five cars, a $1.5 million vacation house in Connecticut, and a penthouse that he rented in Manhattan. And he made all this money making very large loans to very poor people with bad credit.

Glen Pizzolorusso

We looked at loans, these people didn't have a pot to piss in. I mean, they could barely make the car payment, and now we're giving them a $300,000 to $400,000 house.

Alex Blumberg

But Glen didn't worry about whether these loans were good either. That was someone else's problem. And this way of thinking thrived at every step of this mortgage security chain. A guy like Mike Francis from Morgan Stanley, he told me he bought loans, lots of loans, from Glen's company. And he knew in his gut that they were bad loans, like these NINA loans.

Mike Francis

No income no asset loans, that's a liar's loan. We are telling you to lie to us, effectively. I mean, we're hoping you don't lie, but-- tell us what you make. Tell us what you have in the bank. But we're not going to actually verify it? We're setting you up to lie. Something about that transaction feels very wrong. It felt very wrong way back when. And I wish we had never done it. Unfortunately what happened, we did it because everybody else was doing it.

Alex Blumberg

It's easy to ignore your gut fear when you're making a fortune in commissions. But Mike had other help in rationalizing what he was doing, technological help. Mike sat at a desk with six computer screens connected to millions of dollars worth of fancy analytic software designed by brilliant Ivy League graduates hired by his firm. And this software analyzed all the loans in all the pools that Mike bought and then sold. And the software, the data, didn't seem worried at all.

Mike Francis

All the data that we had to review, to look at, on loans that were in production, that were years old, was positive. They performed very well. All those factors, when you look at all the pieces and parts, and you say, well, a 90% no income loan three years ago is performing amazingly well. It has a little bit of risk. Instead of defaulting 1 and 1/2% of the time, it defaults 3 and 1/2% of the time. Well, that's not so bad. If I'm an investor buying that, if I get a little bit of additional return, I'm fine.

Adam Davidson

Wait, Alex, I want step in here, because this is a very important piece of tape. A big part of this whole story, the whole crisis, is that a lot of really smart people, people who knew better, fooled themselves with this data. It was the triumph of data over common sense. Can you play that tape again?

Alex Blumberg

Yeah, sure. Here you go.

Mike Francis

All the data that we had to review, to look at, on loans that were in production, that were years old, was positive.

Adam Davidson

As we now know, they were using the wrong data. They looked at the recent history of mortgages and saw that the foreclosure rate is generally below 2%. So they figured absolute worst-case scenario, the foreclosure rate might go to 8% or 10% or even 12%. But the problem with that is that there were all these new kinds of mortgages given out to people who never would have gotten them before. So the historical data was irrelevant. Some mortgage pools today are expected to go beyond 50% foreclosure rates.

Alex Blumberg

To be fair, they knew there were risks. But investors have a system to assesses those risks. They have the special companies, credit rating agencies, Moody's, Standard & Poor's, Fitch. Their job, their main job, is to assess risk for Wall Street and the global pool of money.

They rate every kind of bond according to its risk. AAA is the safest. Then there is AA, A, all the way down to B and below. And that's all most investors look at that, that letter grade. They trust the credit rating agencies. And these agencies blessed most of these mortgage-backed securities, gave them AAA ratings, which means they were considered as safe as a US government bond.

This was the magic of the whole system. You could take a pool of thousands of risky mortgages and create a security that was called, money good, as safe as any investment out there. At least that's what people thought. We now know that those agencies relied on the wrong data, that same historic data that had nothing to do with these new kinds of mortgages.

Adam Davidson

And then, things got even worse. The thing that took this problem and turned it into a crisis was something else that was new, something called a collateralized debt obligation, a CDO. And that brings us back to the guy we met at the awards dinner in the beginning, Jim Finkel.

Jim Finkel

Well, we're heading to the trading floor of Dynamic Credit, where we have all of our mortgage and CDO analysts, our head trader, our CIO--

Adam Davidson

Jim Finkel runs this CDO shop, Dynamic Credit. It takes up three modified apartments on the Upper East Side of Manhattan. The trading room is like a factory floor for CDOs. It's where they make the things. This is what it sounds like. [SILENCE]

Maybe factory is the wrong term. But this is where he makes CDOs. But what is a CDO? He shows us on a computer screen.

Jim Finkel

I'm going to show you-- here's our deal, Monterey.

Adam Davidson

To start with, every CDO has its own name. Finkel loves his country house in the Berkshires, so he always names CDOs after towns in western Mass, like Monterey.

Jim Finkel

Monterey CDO Limited, we had a 189 assets in Monterey.

Adam Davidson

So that's 189 pools?

Jim Finkel

--189 tranches of different mortgage-backed pools.

Alex Blumberg

Let's translate some of that. A mortgage-backed security, you remember, is a pool of thousands of different mortgages. These are all put together and divided into different slices. Jim used the word tranche. Tranche is just French for slice. Some of these slices are risky and some are not. OK, a CDO is a pool of these tranches, a pool of pools.

And Jim and most companies like his weren't buying the top rated tranches, the safest ones, the AAAs. They were buying the lower rated stuff, the high risk stuff. Jim's company bought tranches that came from Glen Pizzolorusso's company, the guy who hung out at nightclubs with B-list celebrities, the guy who said he was selling mortgages to people who didn't have a pot to piss in.

Adam Davidson

There is another term the industry uses. This is not a joke. They call these lower rated tranches, toxic waste. They are so high risk, they're toxic.

Alex Blumberg

So basically Adam, a CDO is sort of a financial alchemy, right? Jim takes this toxic stuff, these low-rated high-risk tranches, puts them all together, re-tranches them, and presto. He has a CDO whose top tranche is rated AAA, rock solid, good as money. If this seems too good to be true to you, you're in good company. Guys like billionaire investor Warren Buffett said the very logic was ridiculous. But back in 2005, 2006, the global pool of money, they couldn't get enough of these things. And the CDO industry was facing the same pressures everyone else was at every other step of this chain, to loosen their standards, to make CDOs out of lower and lower rated tranches. This is Jim's partner, Tonko Gast.

Tonko Gast

Actually, in 2005 already, we had an internal debate here, because there were two banks coming to us saying, why don't you do a deal with us, BBB securities, and you get paid $1 million in management fees per year? Very clear, just like that, in 2005.

And we declined those deals. We said that we just don't believe that those BBB RMBS assets are money-good. We don't think they are well underwritten. And we think if we do a CDO of those, that's going to blow up completely.

We were a little early in '05 by not wanting to do those deals. And people were laughing at us, to be honest, to say, well, you're crazy. You're hurting your business. Why don't you want to make-- per deal, you could make $1 million a year.

Alex Blumberg

Did someone do that deal?

Tonko Gast

Absolutely. Everybody. Not everybody, but a lot of people did.

Ira Glass

Coming up, how $5 million can get you into $100 million worth of trouble. In a minute, from Chicago Public Radio and Public Radio International when our program continues.

[MUSIC - "HARD TIMES" THE SEX-O-RAMA SOUNDTRACK]

Act Two.

Ira Glass

Well, it's This American Life. I'm Ira Glass. And although I feel fine, I have lost my voice this week. Today's show, a special co-production with NPR News, a step-by-step look at what exactly happened during the sub-prime mortgage crisis. One of our producers, Alex Blumberg, co-reported this story with NPR reporter Adam Davidson. The story continues.

Alex Blumberg

From 2003 to 2006, the housing market was in a classic speculative bubble. Home loans were easy to get. So more and more people were buying houses. The increased demand for houses caused the prices to increase. And the rising prices created even more demand, as people started to look at homes as investments, investments that never went down in value. And in 2003, 2004, 2005 they didn't.

You could buy a house with no money down, turn around and sell it a year later for-- in some areas-- double what you paid. People who had never invested in real estate before started buying multiple properties as investments. There were even shows on TV about how to do it. Here's a promo.

Promo

Get ready for an all new season of Flip This House.

Alex Blumberg

This is A&E's Flip This House. Discovery had the cleverly titled, Flip That House. There were other ones-- Property Ladder, Designed to Sell. Bravo came late to the game, debuting their show, Flipping Out, in November of 2007, well after the bubble had already popped.

Promo

Those white boys from New Haven, going to flip that kitchen. Flip This House premieres Saturday, March 31 at 9:00 on A&E.

Alex Blumberg

The problem was that even though housing prices were going through the roof, people weren't making any more money. From 2000 to 2007 the median household income stayed flat. And so the more prices rose, the more tenuous the whole thing became.

No matter how lax lending standards got, no matter how many exotic mortgage products were created to shoehorn people into homes they couldn't possibly afford, no matter what the mortgage machine tried, the people just couldn't swing it. By late 2006, the average home cost nearly four times what the average family made. Historically it was between two and three times.

And mortgage lenders started to notice something they had almost never seen before. People would close on a house, sign all the papers, and then default on their very first payment. No loss of a job, no medical emergency, they were under water before they even started. And although no one could really hear it, that was probably the moment when one of the biggest speculative bubbles in American history popped.

Strangely, the first people in the mortgage-backed security chain who noticed were the ones near the top, the people on Wall Street like Mike Francis. He can remember almost to the day.

Mike Francis

It would be somewhere around Halloween of 2006. We started seeing our securities that were even six, seven, eight months old start to perform very, very poorly. We started to really dig into the details to figure out what was going on. And then you start seeing, wow, the property values have stopped increasing. Something is really turning around bad here. What do we do?

Alex Blumberg

The problem was that once property values started going down, it set off a reverse chain reaction, the opposite of what had been happening in the bubble. As more people defaulted, more houses came on the market. With no buyers, prices went even further down. And as prices declined, Mike Francis cleared up a mystery. Remember, even though he didn't trust these NINA loans, the bonds he turned them into, they performed well. Well, there was a reason.

Mike Francis

It's obvious that they performed well, now, because their property kept increasing in value. And over time, they could continue to take cash out of it, if they needed to, to pay the bill. In other words, they could take out another loan from the bank, against the value of their house, which because of the bubble was now worth more than they bought it for.

These loans, called home equity lines of credit, became very popular in the early to mid 2000s partly because they were easy to get, but partly because people needed them to continue making their original mortgage payments. To pay off their debts, they went into more debt.

And in late 2006 early 2007-- as prices began their plunge and alarm was spreading across mortgage-backed securities desks all over Wall Street-- the people on Wall Street, like Mike Francis, started backing away from some of the riskiest mortgages that they would accept. Which had a devastating effect on the mortgage companies, which had proliferated to sell them loans, a devastating effect on people like Mike Garner, the mortgage banker in Nevada, for one simple reason.

(SUBJECT) MIKE GARNER: All these mid-size companies like us, we're not using our own money to fund these loans.

Alex Blumberg

The way it worked was that a small bank, like Silver State Mortgage where Mike Garner worked, would borrow money from a big bank, say Citibank or Washington Mutual. Silver State would use this borrowed money to buy up a bunch of loans and then pay back the big bank once it sold the loans to Wall Street. Now these smaller banks were highly leveraged, in most cases 20:1. Meaning in Silver State's case, even though it had, say, only $5 million of its own dollars, it could borrow 20 times that, $100 million, to buy loans with. So in late 2006, Mike is busily at it-- borrowing, buying, selling, paying back, and borrowing again-- when the emails started coming.

Mike Garner

We get an email from a street firm-- I don't know, just say Credit Suisse First Boston. It says, as of-- whatever date-- December 29, we are no longer buying a stated income loan with a FICO less than whatever. And the email would say, there will be no exceptions. Please do not call the pricing desk to make any exceptions for this for this, or whatever.

So you just start flipping out, and say, wait a second. You can't just say that you're not going to buy this with no notice. Well, we're saying it. And there is no notice. So, then you start to scramble and get the stuff out the door as soon as you can.

Alex Blumberg

Because you've already been assembling a bunch of those loans with those characteristics in play somewhere, right?

Mike Garner

Yeah, you've got $20 million, or whatever the number is, sitting there. And you say, oh crap. Well, I had better get those out the door, because within a week of when one street firm says we're not going to buy these loans, you can pretty much expect to see the same email from all them. A lot of times you'll get it from two others the same day.

So you're scrambling to sell them. And you're just going off sheer relationships you have with these guys. Like, OK, I've still got $10 million of these. I know you're not buying them anymore, but you've got to. Come on, you can't just leave me like this. But there comes a point where-- well, there came a point where, basically, all of them just said, we're not buying anything.

Alex Blumberg

For Mike and his company that meant that they'd borrowed tens of millions of dollars to buy loans that now they couldn't sell. And since they had very little of their own money-- just like the home buyers whose mortgages they purchased-- they had no choice but to default on their loan. Silver State Mortgage's nearly 600 employees were out of work quite suddenly.

Mike Garner

It was February 14. The email went out and said, Silver State Mortgage might be going out of business, but-- It was something along these lines-- might be going out of business, but we think we can work something out. So we would encourage you to please come in and work tomorrow, and give us one more day to see if we can work something out. And the next day people came in. And the email went out and said, unfortunately, we were not able to work anything out. So Silver State Mortgage will be closing our doors today.

And that's how most of these lenders go under. Everybody was working, thinking everything's great, chugging along. And all of a sudden, the bank says, you're done. Then people starting grabbing their computers and their copy machines and rolling them out of the building. It was a mess.

My thoughts were like, holy crap. Everybody's just stealing all their stuff.

Alex Blumberg

That happened on February 14?

Mike Garner

Yep. My boss calls it the Valentine's Day Massacre.

Alex Blumberg

For Glen Pizzolorusso, the mortgage sales manager who-- not to dwell on this detail-- was living the life of a B-list celebrity, the end came a little more slowly. So you're at WMC. What was the turning point?

Glen Pizzolorusso

I mean this sounds obscene, but I think it was the first month I got a $25,000 paycheck. And at this time, that didn't cover my expenses. So you're sitting here, and you're like, I just made $25,000 this month, which is more than most people make in six months, and it doesn't even cover my expenses. Now what do I do? And then the next couple months I made like $30,000 or $40,000. And then it went down to $10,000. You could just feel it winding down. You knew the good old days were over. And it was scary.

Alex Blumberg

So give me your situation now. Like, can you pay all your bills now?

Glen Pizzolorusso

Not really. I borrowed some money from some friends-- well, not-- from my dad. Borrowed some money from Dad. I'm living in my house right now. We're working with the bank to try to avoid foreclosure. At this point, I'm dealing with an attorney. I'm trying to figure out if it makes sense for me to just walk away from the house.

Alex Blumberg

And have you been making mortgage payments or not?

Mike Garner

No.

Alex Blumberg

When was the last time you made a mortgage payment?

Mike Garner

January, maybe. And I've been just making them spotty, as I can, just enough to keep them off my back. I mean, I have to watch every penny right now.

Richard

As you can see, this is my living room. I have no furniture in there, because, like I said, it's either buy furniture or pay my mortgage.

Adam Davidson

This brings us back to Richard, the marine we met at the very top of the show. He, like more than 4 million Americans at this point, is fighting to keep his home. He's giving me a tour. And I wanted to talk to him about, what now? What happens next, now that the housing bubble has turned into a crisis?

If he defaults on his mortgage, nobody wins. He doesn't want to leave his house. The investors who own his mortgage, the last thing they want is to own a house in east Flatbush in a declining market with no buyers. So you think it would be easy for both sides to come together and modify Richard's mortgage, figure out something he can afford. You'd be wrong.

Kerry Campbell

Kerry Campbell, nice to meet you. Good, how you doing sir?

Adam Davidson

The offices of NACA, the Neighborhood Assistance Corporation of America in Newark, New Jersey are short on frills. Kerry Campbell, who's helping Richard today, is a counselor here. The goal today is to figure out how big a mortgage payment Richard can actually afford to pay. So Kerry needs to know everything Richard spends money on. They go through his medical bills, his clothing budget. Kerry gently nudges Richard to be realistic, like when he asks Richard how much he spends on gifts for his family.

Kerry Campbell

Gifts for family, how much would you say on average?

Richard

$300 at Christmas time.

Kerry Campbell

January, February-- January through December, Mother's day, Father's day, sisters, brothers, nephews, nieces, significant other, kid's birthday, if you celebrate Christmas-- whole enchilada.

Richard

Let's say $1,000.

Kerry Campbell

That sounds about right.

Adam Davidson

The process we're doing right now, how does this compare to when you bought the house?

Richard

This is totally different. It's brand new to me. But when I bought my house it was just your credit score and can I pull a credit report?

Adam Davidson

So in this whole process, what's the first time someone looked at your finances?

Richard

Today. Today.

Adam Davidson

Not to say the original broker didn't have a process. It just had nothing to do with reality. Kerry shows Richard the loan documents filled out when he bought the house by his original broker.

Kerry Campbell

Here it's saying your base employment income was $16,250 a month.

Richard

What?

Kerry Campbell

$16,250 a month, which means your salary on a yearly basis would be making-- you're making just under $200,000, $195,000 to be exact.

Richard

I wish. In 2005-- and they used my 2005 taxes-- I was making $37,000 a year.

Adam Davidson

Did you know that number until now?

Richard

No.

Adam Davidson

So he stated $16,000 a month. To me, that is shocking. To you, it's not that shocking?

Kerry Campbell

Oh, that's outrageous. But it's a common thing. There's worlds apart from the reality and what's on a lot of these documents.

Adam Davidson

Another thing the papers reveal, how much that creative broker made, $18,500. As Kerry says, that's 18,000 reasons to falsify Richards mortgage documents and to put him in a house he can't afford.

Richard actually qualified for a Veterans Administration Loan at a really good rate. And he had money to put down. But the broker convinced him to take a mortgage that turned out to be much worse, but did have a much higher commission.

Mortgage brokers were walking around east Flatbush knocking on doors, telling just about anybody, hey, we can get you a house. If you have a house, we can get you a big home equity line of credit. This happened in poor neighborhoods all over the country.

And while the FBI and other law enforcement folks say they don't have the exact numbers, it's clear that fraud, like that fraud on Richard's application, was ubiquitous.

At the end of Richard's budget process, the math they come up with is fairly stark. Richard makes more money now. He got a new and better job. So he makes an average, before taxes, of $8,000 a month. Which means after taxes he brings home exactly enough to pay his mortgage and nothing else. All of his living expenses he says, are paid with money he gets from his mom, who is on public assistance, his girlfriend, and his brother.

Kerry runs the software, which says that if Richard is going to stay in his house, he needs a much cheaper mortgage. The interest, which is currently at around 10%, would have to be lowered a lot, to 3%.

Kerry wants to propose this to whoever owns the loan, but this brings him to this peculiar problem mortgage owners face now. They have no idea who that is. Richard's loan has been bought, and sold, and resold, and put into one of those pools owned by investors, maybe an investor like Jim Finkel.

Jim Finkel

150 times was it 3,000-- let's be conservative?

Alex Blumberg

So, now we're back in Jim Finkel's office. He is surrounded by very expensive computers, but he's typing on a cheap calculator. And he's trying to figure out for us how many individual mortgages, how many homes like Richard's, does he and his company own a part of. The calculator method soon fails him, and he turns to one of his number crunchers, a guy named Alex.

Jim Finkel

I can't even imagine-- Alex, do you have any idea?

Alex Blumberg

Alex gets on the phone with Steve, the IT guy.

Alex

How many loans are you running in loan performance, altogether? For all of our deals, how many loans, individual mortgage loans? 16 million loans?

Alex Blumberg

This one CDO factory, this one office, owns a share of 16 million homes. And each of these homes has lots of other owners, people in other CDO offices around the world-- there are lots of them-- and other investors. You start to see what a crazy web of confusing interconnections this whole process is. Now until this moment, we had a theory that the homeowners and the people on the other end, the people at the top of the chain--

Adam Davidson

The investors--

Alex Blumberg

The investors like Jim Finkel--

Adam Davidson

That they had no idea about each other.

Alex Blumberg

Right, but we actually learned that they know quite a lot about each other. They just see each other through a computer screen.

Adam Davidson

Hey, Steve.

Steve Pennington

Hey, what's going on?

Adam Davidson

We find that out when we go downstairs to see Steve Pennington, the IT guy. Steve's actual title is head of financial engineering. He's created his own software program that actually looks at every one of the 16 million loans Dynamic owns part of. It's a spreadsheet. Each line is one loan. And it has all sorts of information like how much the house sold for, what the interest rate is. He points to one field, which is the most baffling one. It's just a cell on a spreadsheet. And it just has 12 letters and numbers in a row. Every letter represents a month.

Adam Davidson

What does the nine mean?

Steve Pennington

It means they are 90 days of, basically, delinquent on their loan.

Adam Davidson

So is this the Matrix, where the guy's looking at the green digits passing. And he's saying, oh there's the redhead, there's the blond? Are you, Steve, seeing lives here?

Steve Pennington

I definitely see lives.

Tonko Gast

Especially when you look at this here, this thing here? That's to me, the most vivid.

Adam Davidson

Just for the record, I see a bunch of-- CCCCC3636CC-- I do not see a human drama.

Steve Pennington

The drama here, is you've got someone who's been paying their loan, and then something's happened. And then they've gone three months delinquent, three months delinquent, six months delinquent, and then three months. So they basically got to this point of six, and then they fought back the current.

Adam Davidson

Now that I've learned the code, now that you've taught me the code, I see it. Like here, he was on time for a bunch of months. Then he went 30 days, 30 days, 30 days. Then he went two months behind. Then he came back. And now he seems to--

Steve Pennington

Right, what's really hard about this is then you watch people-- you can watch over these 12 months, people cycle on and off.

Alex Blumberg

You guys are much more sympathetic. And it might be just because we're reporters, and you want to make us think you're good guys, but you're really cold-hearted.

Tonko Gast

We're human beings.

Alex Blumberg

These guys are hurting you. Their irresponsibility is costing you money and work.

Tonko Gast

That was up to us to think about three years ago.

Alex Blumberg

Do you have any anger when you look at this?

Tonko Gast

No, not at all. This is pure sadness.

Alex Blumberg

This is where the partnership of borrowers like Clarence Nathan and investors liked Jim Finkel has ended up. Tonko Gast estimates that most of the AAA rated mortgage-backed CDOs that the industry created since 2006 are now worth less than half their value. Some are worth close to 0.

But remember, to all the investment managers in the global pool of money who bought them AAA meant safe as government bonds. AAA was called a cash equivalent, money in the bank.

It's as if the global pool of money put trillions of dollars in a savings account, came back one year later, and found out that half the money was gone. Or put another way, it's as if the global pool of money thought it was putting trillions of dollars in a savings account, but really half of it was going into a furnace. The money is gone, burned up, never to come back. And that has led to a new term you've been hearing.

Adam Davidson

Yeah, maybe you've noticed that the press and others don't call it a sub-prime housing crisis as much. They're now calling it a credit crisis. The global pool of money still has no idea how much money they lost, how much went into the furnace. And because of that, they've totally changed their thinking.

They used to be obsessed just with getting some kind of profit, any higher interest rate return. Now the global pool of money has the exact opposite obsession. It wants no risk whatsoever. It just wants safety. Suddenly, those US government treasury bonds-- still near the historic lows of 1% and 2%-- are beautifully attractive because they're safe. They will never blow up like sub-prime CDOs did.

The global pool of money is avoiding anything with even the slightest hint of risk. And that affects everybody, no matter who you are. It's harder to borrow money to buy a house, or build a factory, or bring your country boldly into the 21st century.

Take Iceland. A year ago, it was easy for them to borrow billions. Now they're seen as too risky. Their central bank has to pay more than 15% interest to get anyone to loan them money. They could do better putting their national debt on a credit card. Hungary, Kazakhstan, Turkey, they are all in similar situations.

You might have heard about problems in student lending. Companies that needed credit to survive are shutting down. The US expects more than 1.1 million bankruptcies this year, twice the 2006 number.

This freezing of credit all around the world is something new. The world has never seen anything on this scale. When the crisis hit last August, central bankers and finance economists couldn't figure out just how bad things might get. There is this question people would ask, will things get like the 1930s or the 1970s?

There's a real fear that just like in the '30s, hundreds of banks would collapse. There would be massive unemployment. There was talk of a new, Great Depression.

Alex Blumberg

That talk seems to have faded. And there's more talk that the next few years will feel like the 1970s. There are lots of technical differences between this crisis and Jimmy Carter's malaise. But for the average person it could feel the same. It's not an out-and-out depression. Everything's just kind of crappy. And not just in housing and banking, but for the economy as a whole. It's barely growing. There aren't a lot of new businesses, new jobs, unemployment keeps creeping up. We're just sort of stuck in neutral for a while. Anyone under, say, 45 probably doesn't remember that 1970s malaise too well. Anyone under 30 has barely known a US economy that wasn't growing. Now, there's a decent chance we'll all get to see what life felt like in the '70s, which isn't great. It's pretty bad, actually, unless you're comparing it to the 1930s.

Credits.

Ira Glass

Alex Blumberg and Adam Davidson. Alex, my voice is so bad, I think maybe you should read the credits. Why don't you do it?

Alex Blumberg

All right, Ira. I hope you feel better. I'm going to bring Adam in here to help me to, since I've never done this before.

Adam Davidson

Thanks today to Ellen Weiss at NPR who made this collaboration happen this week between the news division at NPR, where I work, All Things Considered, and This American Life.

Alex Blumberg

Where I work. Thanks also to Mary Ann Casavant, Anna Chai, Kevin Byers, the fantastic housing blog, Calculated Risk, Alexis Grenell, Stephanie Cohen Glass, Sanjeev Handa, Charlie Ledley, James Scurlock, Chris Turpin, Elaine Glick, Mark [? Adelson, ?] Dan Naygrow.

This American Life is distributed by Public Radio International.

[FUNDING CREDITS]

WBEZ management oversight--

Adam Davidson

No, I want to do this one.

Alex Blumberg

OK, here you go.

Adam Davidson

WBEZ management oversight for our program by Ira's boss Mr. Torey Malatia. He and Ira go out at night sometimes together. It's pretty chill. Torey describes it like this--

Glen Pizzolorusso

You know, we order probably three or four bottles of Cristal at a $1,000 a bottle. Everybody's like, whoa, who's the cool guys?

Alex Blumberg

I'm not Ira Glass.

Adam Davidson

I'm not either.

Alex Blumberg

But we will be back next week with more stories of This American Life.

Announcer

PRI. Public Radio International.