With the housing boom still in full force in early 2006, Long Beach Mortgage Co., one of the nation's biggest subprime lenders, sent its eager Wall Street investors yet another package containing thousands of new home loans.
Among them was a mortgage for a modest, two-bedroom home on a quiet suburban street outside Washington, D.C. - taken out by a borrower who could not afford it.
The mortgage was rolled into a bundle of bonds worth $1.7 billion, assembled and marketed by Goldman Sachs and other venerable financial companies. The bonds were blessed as the highest possible quality by the major credit raters and then purchased by some of the world's most savvy institutional investors.
By now it is well established that the collapse of such mortgage-backed securities set off a chain reaction that nearly wrecked the global economy last year. This is the story of one risky mortgage and its path through the U.S. financial system.
It is also the story of one man who succumbed to the lure of easy credit and lives in financial purgatory while he waits for his bank to decide if he is worthy of a loan modification.
The Cold Call
Eliseo Guardado, a legal Salvadoran immigrant who speaks little English, hadn't imagined he could qualify for a home of his own until a real estate agent cold-called him one day in 2005.
At the time, his drywall subcontracting business was getting steady work in a robust housing market. The economy was strong. The Spanish-speaking real estate agent convinced him it was time for a move, to trade in his $600-a-month basement apartment for a house by teaming up with his brother. Guardado wouldn't even need to make a down payment.
They settled on a fixer-upper in Hyattsville, Md., with a price of $320,000. Guardado said that a mortgage broker hooked him up with Long Beach Mortgage, which offered a $256,000 first mortgage with an adjustable rate. Reflecting its subprime nature, the loan started at 8.750 percent for the first two years, compared to 6.6 percent for a typical 30-year fixed loan in mid-2006, according to HSH Associates, which tracks the mortgage market. Guardado also took on a second mortgage from Long Beach, a $64,000 loan fixed at 10.85 percent.
With no money down, it seemed too good to be true. Yet even before he signed the closing documents in February 2006, Guardado says he had an inkling that the dream of homeownership could turn into a nightmare. The mortgage broker kept revising the "good faith estimate" of the monthly payment. What started below $2,000 a month increased to nearly $3,000.
Guardado says he tried to back out of the deal. He says he only went through with it after his broker said he might face a lawsuit if he reneged.
A Grain in a Silo
Once the deal was inked, Long Beach fed that mortgage into the financial pipeline. Such loans were packaged into bonds to be sold to investors, and lenders like Long Beach would use the proceeds to lend even more money, keeping the cycle going.
Guardado's main loan became a tiny part of a security named Long Beach Mortgage Loan Trust, Series 2006-3. It included 8,140 mortgages worth a total of $1.74 billion. The bonds in the series were sold in April 2006 with underwriting by Goldman, Sachs & Co., Deutsche Bank Securities Inc. and WaMu Capital Corp., a subsidiary of Washington Mutual, Long Beach's parent company.
The investment banks were supposed to assign auditors to review the mortgages in the package and make sure they followed underwriting rules: Did the applicant's credit score meet the guidelines? Did employment and income claims check out? The buyer banks could kick out of the pool any loans below the standard.
But the system of checks and balances broke down in the frenzy. In Guardado's case, the mortgage broker noted in the documents that his client had a gross monthly income of $8,760, or $105,120 a year. Guardado says now that he actually was making less than $2,000 a month, but signed the documents without understanding them. No one apparently ever checked the loan papers against his tax returns, which he had authorized the lender to review.
Once the bonds were sold, the investment banks rebundled them with other securities into complex financial products called collateralized debt obligations. That earned the banks lucrative sales fees and commissions but made the original collateral - the home loans - even less tangible to investors and more difficult to trace.
"Like the wheat that's deposited into a silo, there are no records to track where the particular grains were sold off," said Christopher L. Peterson, a law professor at the University of Utah who specializes in the financial system.
That is the case with Long Beach's 2006-3 series. Most of the $1.7 billion in bonds have proved impossible to trace. But a review of SEC documents by the Huffington Post Investigative Fund shows that among the dozens of buyers were John Hancock Trust, part of the insurance and investment firm; and UBS PACE Select Advisors Trust, an arm of the Swiss financial services empire, UBS AG; and EQ Advisors Trust, part of the AXA Equitable Life Insurance Co.
The Long Beach bond offering was cut into investment slices, each representing a different risk of default. According to the SEC filings, all three funds purchased the least risky slice -- bonds that were first in line for repayment as money from the mortgages came in each month.
Of the three funds, UBS PACE acquired the biggest chunk, $1.25 million worth. It was a small part of the company's $55.3 million investment in mortgage-backed securities, according to the USB trust's 2006 first quarter report. John Hancock Trust acquired about $200,000 worth in 2006, part of $55.4 million in asset-backed securities, according to its third quarter 2006 report. EQ, meanwhile, had a little more than $69,000 worth of the securities on its balance sheet as of the company's third quarter 2006 report.
'$300 Million in Losses'
The investors relied largely upon the glowing ratings given to the Long Beach bonds by credit raters. In July 2006, Standard & Poor's gave its highest AAA rating to all of the "A" classes of the Long Beach series, in which Guardado's loan was bundled. Moody's was similarly bullish about the bonds.
But by later that year, it was clear the housing boom was ending. Defaults began to rise, threatening the stream of payments the bond buyers relied upon for interest payments. In January 2007, market analysts were already panning mortgage-backed bonds issued in 2006 as the worst performing in the three-decade history of private mortgage-backed securities. One report titled "Sour Grapes" by Wachovia Capitol Markets, LLC concluded that the "2006 vintage" was turning out to be one of the riskiest ever produced.
The three funds identified by the Investigative Fund as investors in Long Beach Mortgage Loan Trust 2006-3 have been fortunate. They have received all of the principal and interest they are owed, because investors in their slice of the bond offering got first crack at the slowing flow of payments from borrowers.
Others didn't fare as well. Overall, as of Nov. 25, 2009, investors in the trust had written off $605.7 million, according to Jerry Breen, senior director for marketing and strategy at Lewtan Technologies Inc., which operates the Absnet.net market analysis site. Ten of the riskier investment slices have been written off altogether.
Of the more than 8,000 mortgages that started out in the package, only 2,820 were listed as active loans at the end of November. Of the rest, more than half - 2,767 loans -- were liquidated by the bank after the homeowners stopped paying, according to Deutsche Bank. Another 2,386 managed to refinance their way out of their pricey loans after their low teaser interest rates adjusted skywards.
More than half of the remaining loans are in some form of distress, according to the November report. They are either behind on their payments, in foreclosure or bankruptcy. Those homeowners probably couldn't refinance if they wanted to, Breen said. The problem: tighter underwriting standards adopted by the banking industry in the wake of the mortgage meltdown. With housing values considerably below the 2006 peak, it could be a decade before the homeowners have enough equity in their houses to be able to get a new loan, he added.
"It was a perfect storm," Breen said of Long Beach Mortgage Loan Trust 2006-3, because it brought together one of the most notorious subprime lenders with Goldman Sachs, which underwrote some of the worst performing deals in that year. "It was a 2006 vintage deal at the peak of the bubble, and in hindsight the worst possible collateral was being shoved into these deals."
Sitting in Limbo
Guardado's loan is one of the distressed mortgages in the bond package. After he bought his house, his income as a drywall installer nose-dived along with the construction industry. His brother moved out.
In April 2008, the rate on Guardado's first mortgage reset upwards, eventually increasing his monthly payment from $1,995.70 to $2,168. That was on top of the $602.25 monthly payment on his fixed second mortgage. Trying to keep up, Guardado soon ran through $16,000 in savings and racked up credit card balances. His truck was repossessed.
Last year, he stopped paying both mortgages. Guardado applied to the bank for a loan modification with the help of Jose Huarachi, a former loan officer at a commercial bank, who worked as an organizer for the national group ACORN at the time. Huarachi was laid off in October, when the troubled activist organization closed many of its offices, but he continues to help Guardado and others read and respond to correspondence in English from their mortgage banks.
After nearly a year of exchanging phone calls and letters with bank officials and several false starts, Guardado was offered a trial modification in August that slashed his monthly payments by two-thirds, to $999.88. The bank promised Guardado, who now lives with his girlfriend and their infant son, that if he could meet the new payment for three months, it would negotiate a new deal with him.
The offer was made through Making Home Affordable, the Obama administration's high-profile program to help struggling mortgage holders stay in their homes.
Five months and five payments later, Guardado, who found a job working full time for a landscaping company, is still waiting for the bank to make him an offer.
It turns out he's not the only homeowner stuck in limbo. As of the end of November, 697,000 trial modifications had been initiated nationwide as part of the Making Home Affordable program but less than 31,400 of those homeowners have been offered permanent new repayment terms, according the U.S. Department of the Treasury.
Treasury officials have publicly chided the banks over the bottleneck and this month disclosed details about the number of delinquent mortgages being serviced by each of the major banks.
JPMorgan Chase, the bank that now services Guardado's loan, is the second-largest servicer of these distressed loans, behind Bank of America, according to the Treasury report. Guardado's case is one of nearly 137,000 in the trial phase at JPMorgan. Only 4,302 of those loans have been given permanent new terms, according to the report.
(The bank says it has actually offered Making Home Affordable trials to nearly 200,000 loans out of more than 500,000 modification offers to struggling mortgage holders nationwide as of Dec. 8.)
JPMorgan said more than half of the mortgage holders in the program have made the requisite three payments but have failed to send it all of required paperwork, while others have simply failed to make all the payments.
Christine Holevas, a JPMorgan spokesperson, said that in Guardado's case, he's made all his payments since his trial began in August and submitted all of the paperwork. But, she said, two of the forms are now older than 60 days, which means they must be resubmitted.
Huarachi, the former ACORN organizer who continues helping Guardado, said the two friends sent in complete packages several times but the bank keeps sending letters saying they didn't get the documents or asking for changes in paperwork already submitted. Sometimes the requests are completely off base - like the time the bank asked Guardado for proof of payments to a homeowners' association, which his neighborhood does not have.
"We are going to send in all that paperwork, and I am 100 percent sure that they will ask for all those papers again," Huarachi said with a wry tone of resignation.
Guardado said he will continue to work with the bank but would love to put the ordeal behind him. "It's just a constant worry" not to know whether he will be able to save his home, he said.
As for many of the investors who purchased the bonds that included Guardado's loan, prospects for recouping their cash seem bleak.
"The two parties that have gotten shafted are the borrowers, who couldn't afford the loans they were sold, and the investors that have conservatively lost half a trillion dollars, so far," said David Grais, a New York attorney representing hedge fund investors in a lawsuit against another subprime lender, Countrywide Financial Corp. "Everybody in the middle has kept their fees and are making out just fine."
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