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The Two Americas of Credit

More details came out over the weekend about the way Countrywide Financial Corp’s “Friends of Angelo” mortgage loan program worked, and how the special deals for important people played out. My favorite nugget from this Washington Post piece was how Sen. Kent Conrad, D-N.D., called up Mozilo for a loan after getting his phone number from James Johnson - the former Fannie Mae CEO who resigned from his post vetting vice presidential candidates for Sen. Barack Obama after stories surfaced that Johnson received loans on favorable terms from Countrywide. Conrad said - apparently with a straight face - that he didn’t ask for or seek special treatment. Unlike millions of other borrowers who used Countrywide’s 800 number for loan applications, Conrad simply called up the company’s CEO with a phone number provided by the former CEO of Fannie Mae. Nothing special there, I guess.

Another supposed recipient, Sen. Christopher Dodd, D-Conn., declared that he would never ask or expect to be treated differently than anyone else seeking a loan, and called any suggestions to the contrary “outrageous.” Well, no. The Post quoted Guy Cecala, the publisher of Inside Mortgage Finance, the trade Bible of the subprime loan industry, as saying that Mozilo “handed out like party favors” his offers of VIP treatment on mortgage loans to friends. It was no secret that if you were somebody big - maybe, say, the the chairman of the Senate Banking Committee, or the Senate Budget Committee - you could go to Angelo to get a deal on your loan. At a minimum, it’s fair to suggest that Dodd, Conrad, Johnson, and the rest, either knew or should have known that they might be treated differently than the average Countrywide customer. Dodd and his wife say they shopped around and other lenders offered competitive rates; why not just go with them, and avoid any potential pitfalls?

Whether any or all of them saved a few thousand dollars isn’t the point, however. Countrywide’s special treatment for friends of the CEO wasn’t all that unique in the credit industry. Consider the credit bureaus, which keep the information that determines whether you’ll get a loan and how much you’ll pay for it. I included in my story earlier this month an interview with David Szwak, the Louisiana attorney featured in 2006’s Maxed Out, a well-received movie on lending and debt. Szwak contends all three credit bureaus keep VIP lists of judges, members of Congress, and celebrities, to make sure their files are handled carefully and kept free of errors. The rest of us can just put up with our mistake-ridden files, apparently. The bureaus haven’t owned up to the practice, but Szwak has depositions from former employees and other documentation at myfaircredit.com.

While reporting that story, Adam Levitin, a Georgetown University law professor and credit expert, told me that credit card companies, too, have a VIP structure in place, so that important customers who call receive better service than the average cardholder. In some ways, Levitin said, this two-tiered system of credit is smart business, a way for credit bureaus, lenders, and credit card companies to avoid antagonizing important people who could retaliate against them, while dismissing the rest of us, unless we can afford to hire an attorney and fight like hell. If you can’t afford one, then just forget it. The business philosophy here, Levitin said, is that “We’ll be unfair to you, but if you push back, we’ll be reasonable.”

Well, good to know. Talking about VIP lists serves another valuable purpose, as well: Shedding light on the two-tiered credit system that existed in the mortgage market, a little-known and mostly ignored reality that explains why some borrowers ended up caught in the foreclosure crisis.

Patricia McCoy, a University of Connecticut law professor who has extensively researched subprime lending and securitization, told me not long ago that, out of curiousity, she tried once shopping around in the subprime market for a loan, to understand what the experience was like.

She was astounded. In the subprime market a borrower could not get a lock-in agreement from a lender. Those agreements, in writing, document the rate the lender and borrower agreed on. It locks in the rate, provided the loan is closed in a reasonable time period, and details the points to be paid. Lock-in agreements are a basic tenet of the prime market, almost like a consumer’s right: You can be sure the rate you agreed on with your lender won’t change by the time you come in to sign your loan papers, and you’ll have some idea of the fees you’ll be paying at the closing.

If you’re a prime borrower, that is. In the subprime world, lock-in agreements were non-existent. Lenders didn’t even provide firm price quotes to customers before they applied for loans, and often not until closing, McCoy said. By then, of course, it was too late to shop around for the best deal. Borrowers routinely walked into closings not knowing for sure what the loan would cost - either the rate or the fees. They rarely, if ever, qualified for the best available rate advertised by the lender. Can you say bait and switch? Remember, in the subprime market, lenders used risk-based pricing, in which the price of a loan varied according to the lender’s determination of the likelihood of a borrower paying back the loan. Some lenders regularly would figure out the true loan price, “and then in the backroom, they would jack up the price even more,” McCoy said. A borrower would never know.

In the prime market, borrowers would never put up with this. A borrower surprised at a closing had options. Those borrowers walked out, or consulted with their real estate attorneys, or had their agents step in. In the subprime market, closings weren’t so simple. Borrowers either couldn’t afford real estate attorneys, or they didn’t have agents, and, most importantly, they had no experience with a closing before, and neither did anyone else in their families. Cheryl Boone, a single mother of two in East St. Louis, Ill., told me for a piece I once wrote that her mortgage broker showed up at her office and told her that if she didn’t sign the mortgage papers within 45 minutes she would lose the house. She’d never owned a home before, and had never been to a closing. She was by herself in this transaction, scared, and she did what she was told, without fully understanding what she’d signed.

She paid more than 13 percent of her $60,000 mortgage in points and fees. Her house later was determined to be worth $15,000, and unfit to live in.

I often hear people say that they can’t understand how someone could take out an adjustable rate mortgage without knowing how the loan worked and anticipating that the rate would go up. Even after all the publicity about the mortgage crisis, it’s still not clear to many people that the rules in the subprime world were very different from those in the prime market, and that otherwise respectable banks and financial firms knew it and took advantage of it. A lawsuit filed recently by the Massachusetts Attorney General makes this clear. The AG sued H&R Block - you know, that upstanding, mainstream financial institution - for its behavior in selling subprime loans. The suit, which named H&R Block and its former mortgage arm, Option One, contended the firms targeted black and Latino borrowers for risky mortgage products, with the companies looking specifically to operate in communities where borrowers had a lack of familiarity with the credit system. The firms, the suit said, encouraged brokers and loan officers to partner with minority real estate brokers, and to visit community centers and places of worship to find customers and gain their confidence.

So maybe you did understand that the rates on the loan you were about to sign would go much higher. Or maybe you didn’t. But either way, the nice man you met through your church reassured you that you’d be able to refinance out of it before that happened, or that you didn’t have to worry, you were getting a great deal. And for all you knew, that was enough.

Now that the housing bubble has burst, there are recriminations and finger-pointing. There’s a credit crunch, and a fight over a mortgage rescue plan. But there’s little that will change the two Americas of credit, the two-tiered system that looks out for the powerful and the important. Johnson, Dodd, and the others can retreat to those second homes for which they sought mortgage refinancings to escape the stress of this controversy. For borrowers in that other America of credit, there’s long lines at the local legal aid office, and lives blown up in their faces.

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