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The Bullies of Wall Street

Matt felt puffs of warm, wet air hitting his cheek. He opened his eyes and saw the source: a large, shiny black nose just a few inches from his face. Two wide-set brown eyes stared at him intently. Attila had probably been awake for hours, patiently waiting for Matt to get up.

Matt lobbed his arm over the old German shepherd’s neck and scratched him behind the ears. Matt’s mom usually didn’t let Attila sleep with him. But she had given in to Matt’s pleas the night before, realizing that it would be the last he would share with his dog.

Matt had never known a day without Attila. His parents had adopted him from a dog shelter twelve years ago, just a few months before Matt was born. He was a big puppy, with huge paws, which was why Matt’s dad, a history teacher, decided to name him after Attila the Hun, the ferocious fifth-century warrior who had conquered much of Europe. Attila eventually grew into his paws, weighing over a hundred pounds, big for a German shepherd. His size was now a problem, as Matt’s parents couldn’t find a place for them to live that would take a dog of his size. The family was moving soon, and all of the apartments they had looked at either prohibited pets or allowed only small ones.

Matt didn’t want to get up. He wanted to lie there forever with his dog, thinking back over all of the good years they had spent together. Attila used to be the fastest and smartest dog of any in his neighborhood, making Matt the envy of every kid on his block. His friends would come to his house and beg for the privilege of throwing sticks for Attila to fetch and watching him perform tricks. The usual “sit,” “beg,” and “roll over” commands were nothing for Attila. He could climb the ladder of Matt’s backyard playground set and slide down the slide. He could jump through a hoola hoop and catch Frisbees six feet in the air. He could play tug-of-war with four kids on the other side of the rope, and still win. He didn’t just shake. He high-fived.

But that was when Attila was younger. Attila walked slowly now, suffering from arthritis in his hips, which Dad said was common in shepherds. His hearing was almost gone too, so he could no longer always hear Matt’s commands.

Matt started to sob softly, and then came an all-out bawl. He gathered up the old dog’s coarse, dry fur in his fist and squeezed. Attila belly-crawled closer to him to lick the salty tears from his cheeks. Who would adopt this old dog, who only had a few years left? Who would take in this deaf fellow, who sometimes had accidents in the house and needed help going up and down the stairs? Matt’s parents had assured him that the shelter would find a good home for Attila. But Matt had read in the newspaper that lots of families like his were losing their homes and having to give up their pets. The shelters had too many dogs for adoption already. After a time, when they ran out of room, they had to put some “to sleep,” which was a nice way of saying that they gave the dogs drugs that made their hearts stop.

Why did they have to move at all? Matt loved their house, with its big fenced-in backyard. He had lived there his entire life. He loved his upstairs bedroom, with the window that overlooked a maple tree that his dad said was a hundred years old. In the summer that tree was full of huge green leaves bigger than Matt’s hands, which turned to shades of bright orange and crimson in the fall. Matt used to climb that tree often to tease Attila, hiding from him among those humongous leaves.

Now they were moving to an apartment where he would share a bedroom with his brother. They wouldn’t even have a yard, only a small balcony.

Many of his friends’ families had already left his Boston neighborhood. About one-third of the houses on his block were empty. Some of the families had to give up their houses because the parents lost their jobs. But many others, like Matt’s family, simply couldn’t afford to keep paying for their houses.

Matt’s dad had tried to explain it around the dinner table one night.

“I made a mistake,” he told them simply.

He said that they had borrowed money on their house with something called a 2/28 mortgage, but when he had done it, he hadn’t fully understood how the mortgage worked. Unlike their old mortgage, the loan payments on this mortgage had gone up suddenly, and Matt’s parents didn’t make enough money to afford those higher payments. They were several months behind on the loan, and the man who had arranged for the mortgage was telling them that they could no longer keep the house.

“If we don’t leave,” his dad solemnly told them, “he said the sheriff will come and make us leave.”

Matt vaguely remembered a man coming to their house a few years earlier, encouraging his parents to take out a new loan that he called a “refinancing.” They were all excited because the man said they would get enough money to replace their leaky roof and have some left over for a nice vacation. They thought this man was trying to help them. His dad took the loan and replaced the roof, but instead of taking a vacation, he put the extra money in a savings account for Matt’s college.

But now, his dad told them, “All of our savings are gone.”

Matt’s college account was gone. Everything. His parents had used it all up trying to make the higher payments so they could keep their house.

Matt had never seen his dad cry, but he did that night. And then things got even worse when they couldn’t find a new place to live that would take Attila.

Matt’s thoughts were interrupted by his mother calling him to breakfast from the kitchen downstairs. He climbed out of bed and saw Attila struggling to follow. He gently wrapped his arms around the old dog’s hindquarters, lifted him to a standing position, and helped him walk to the edge of the bed, where Matt had built a ramp out of sofa cushions. With Matt holding up his hindquarters, the dog shuffled down the cushions onto the floor. Matt pulled on a pair of jeans and a T-shirt and ran his fingers through his hair as Attila patiently waited. Then together they left the bedroom and slowly made their way down the stairs, Attila softly whimpering in pain with each step.

Matt took Attila outside behind the old tool shed where Attila always did his business. Then they found a sunny patch in the backyard and lay down together, Matt on his back, gazing up at the clear sky. He knew this could be the last time the dog would enjoy the coolness of thick grass underneath him and the warmth of the morning sun. Matt winced at the memory of his visit to the shelter with his parents a few weeks earlier to make arrangements for Attila. He had had to fight off tears when he saw the small chain-link pens the dogs lived in, with their hard gray concrete floors.

Matt’s mom brought Matt an egg sandwich and sat next to him on the grass while he ate it. Pretty soon Matt’s dad and brother joined them in the backyard. They sat in a circle around Attila, simultaneously giving him scratches in all his favorite places: behind his ears, his neck, his tummy, and on his hind end, right above his tail.

“We have to go now,” Matt’s dad finally said. “Matt, get Attila’s dog bed and blanket, and put them in the car.”

Matt retrieved Attila’s bedding from the corner of the kitchen where he usually slept and carefully arranged it in the backseat of their minivan. When Matt was finished, his dad picked Attila up and gently laid him in the car. Matt and his brother squeezed in on either side of the dog and petted him all the long way to the shelter. Matt rolled down his window and, with his brother’s help, got Attila close enough to the window that the old dog could stick his nose out and feel the wind rushing by.

The shelter’s staff were expecting them when they arrived and had already prepared Attila’s pen. The family made a little parade back to Attila’s new home. A shelter worker led the way, followed by Matt’s dad, carrying Attila, Matt with the dog bed and blanket, his mom with Attila’s food bowl, and his little brother with some chew toys. They all stood around him in the pen, hugging and kissing him one final time. As they left, the old dog looked confused and struggled to follow them out before the shelter worker closed the gate. Attila looked at Matt through the chain link, questioning, his ears and tail down, as if he thought he had done something wrong. Why was he in this strange, cold place? Why was Matt leaving him? Matt didn’t understand either.

The rest of the day the family spent packing and moving all of their stuff to their new two-bedroom apartment. Matt hated the cramped apartment. He hated not having a yard. He hated the extra mile he had to walk to get to school. But most of all, he hated not having Attila.

Every Saturday morning for three months the family made the long drive from their new apartment to the shelter to visit their beloved pet. At each visit they would ask the shelter workers if any families had asked about adopting the old dog. The answer was always no. Then one Saturday the woman who ran the shelter asked to talk with Matt’s parents privately.

Matt and his brother took Attila to a small courtyard behind the shelter while their parents met with the woman. Above the courtyard’s high concrete walls they could see the tips of trees whose browning leaves broke easily from their branches, slowly fluttering down in the autumn breeze. Attila would perk his ears each time a leaf fell close to him.

Matt’s parents soon joined them and suggested that they stay with the dog through lunch. Matt’s mom left to get some sandwiches and doggie treats at a nearby grocery store. They picnicked in the courtyard, and Attila proved that he could still count and high-five with his paw when rewarded with one of the treats.

After lunch they took Attila back to his pen and made him comfortable on his bed.

“You should stay with him for a while,” Matt’s mom said to him. “We’ll wait outside by the car for you.”

Matt understood what she was telling him. He didn’t want to understand, but he did. He stayed for a long time, stroking Attila’s back until the old dog drifted off to sleep. Then he kissed him in what he thought would be his second and final good-bye.

They drove back to the apartment in silence. Matt went to the bedroom he shared with his brother and closed the door. He had to be alone.

I can’t let it happen, he thought to himself. There has got to be a way to save him.

He logged on to his computer and started searching Google. He used the search terms “German shepherd,” “help,” “needs home,” and “please rescue.” Finally, he found a website for an organization that said they took in German shepherds who needed homes and that they had a big farm where they kept them, just a few miles away. Matt sent a desperate e-mail to the address listed on the website. He explained the whole situation, about his family losing their house and how the shelter where Attila was staying would soon put him to sleep.

Matt tossed and turned that night, hoping against hope that this organization would help him. He rose early the next morning after hardly sleeping at all. The first thing he did was turn on his computer to check his e-mail messages. His heart started pounding when he saw a message from the shepherd rescue organization.

“Dear Matt,” the e-mail began. “We were deeply moved by your story and the obvious love and devotion you have for your dog. And we are so sorry that your family lost your house. This has been happening all over the country. We have too many dogs now and cannot accept any more. But when one of our volunteers saw your e-mail, she agreed to adopt Attila. Her name is Marsha, and she lives in the country with lots of land. Attila will be quite happy there, and you can visit him any time you want.”

The rest of the e-mail provided driving instructions to Marsha’s house, and said she would be waiting for him that day. Matt excitedly printed the e-mail, then woke his still-sleeping brother. “GET UP!” he shouted. “We have to go get Attila.” He rushed out of the room to give his parents the good news, showing them the e-mail. For the second time in his life, Matt saw his father weep, and he realized how hard losing their house and Attila had been on his dad.

It was Sunday, and Mom insisted that they go to church to give their thanks before driving to the shelter to pick up Attila. She called the shelter to let the staff know they had found a new home for Attila and would be by around noon to pick him up. Matt hardly heard the sermon at all—he was so anxious to rescue Attila from the shelter.

The shelter workers had everything packed up for them when they arrived, and they helped Matt’s family carry all of Attila’s things out to the car. Attila lay down in his usual place between Matt and his brother in the backseat, sniffing at the air coming through Matt’s open window.

They drove for nearly an hour before reaching Marsha’s house. As they turned into Marsha’s driveway, they saw a beautiful old wood farmhouse surrounded by acres and acres of land. Marsha came out of her house to greet them, then led them into the house and showed them a corner of her kitchen where Attila would be sleeping. Matt carefully arranged Attila’s bed, blanket, bowl, and toys there. They spent the rest of the afternoon with Marsha, sitting under an old maple tree in her front yard, telling her stories about Attila, the things he liked to do, and how he could still do simple tricks like counting and high fives. She said that he was a very special dog, and that she would take good care of him, and that they should come back and visit as many times as they wanted.

As the sun started to set, they said their good-byes, and Matt gave Attila a very long hug. It wasn’t so hard to say good-bye this time, because he knew this farewell would not be his last.
Houses are big investments for most families. They can cost hundreds of thousands of dollars, which is much more than most people make in a year. For that reason, people borrow money to buy their houses and then pay the loan back over a long period of time, usually thirty years.

Where does the money for these loans come from? Most of it used to come from banks who would take some of the money that people deposited into their bank accounts and lend it to other families to buy homes. Banks that specialized in making home loans were called “savings and loans” or “thrift” institutions. Maybe you have seen the movie It’s a Wonderful Life, when Jimmy Stewart explains to people who are trying to withdraw all of their money from his bank that he doesn’t have it all—that most of it has been lent out to their neighbors to buy homes.

This is how it would work: Families and others would deposit their money into the bank. In return the bank or thrift would agree to pay them something called “interest” on their deposits for as long as they left their money at the bank. Interest is usually expressed as a percentage. For instance, a bank might agree to pay a family 5% on their deposits each year, or $5 for every $100 deposited. (Interest rates on deposits are a lot lower than 5% as I write this in 2013, but we will use that number to keep the math easy.) The bank would then take some of that money and lend it to other families to buy houses. The bank would charge those families a higher interest rate—say, 10% (again, interest rates on home loans are lower as I write this, but 10% keeps the math easy). With the interest earned on their loans, the bank could pay depositors their 5% and have another 5% to cover its own expenses and salaries for bank employees. By charging homeowners higher interest rates than it paid depositors on their bank accounts, banks made money.

But there were risks in doing business this way. One risk was that the homeowner might not pay the loan back. In that case, the money would be gone, but the bank would still need to make good on its obligations to depositors. To reduce this risk, banks would require something called a mortgage from homeowners. A mortgage meant that if a homeowner could not pay the loan back, the family would have to give up their house to the bank, which could then sell it to someone else to get its money back.

But taking someone’s house from them was an expensive and unpleasant process. Bankers making mortgage loans usually knew the families who borrowed from them. They might have kids going to school together, or they might belong to the same clubs. It was bad for a bank’s reputation to take a house away from someone in their community. And even when they had to take back the house, banks couldn’t always sell it for the full amount of the loan. For that reason, banks were usually very careful about making home loans and took steps to make sure the borrower had enough income to pay the loan back. Banks were so careful, in fact, that prior to 2007, less than 2% of all homeowners failed to repay their home loans.
When mortgages were made by banks lending out their deposits, the percentage of borrowers who defaulted on their mortgages stayed low. That is because banks were scrupulous about making sure that borrowers could repay them. If the borrowers couldn’t repay, the banks had to suffer the losses.

So while this kind of lending worked well to make sure that home buyers got mortgages they could afford, it created another kind of problem called a “duration mismatch.” You know what a mismatch is. If you play a soccer game against another school and lose 7 to 0, your teams were probably mismatched in their skills and abilities. If your three-year-old brother puts on your mom’s high heels, his feet will be mismatched with her shoes (among other mismatches). Well, 30-year, fixed-rate loans didn’t match up very well with bank deposits. The problem was that the interest rate on those loans was fixed for 30 years, but the interest rate on deposits changed all the time.

In the 1970s, mortgage interest rates were around 8% to 10%, while the interest rates banks had to pay on deposits were more like 5% to 7%. This generally meant that the interest that banks received on their loans was about 3% higher than the amount they had to pay out on their deposits. However, in the late 1970s, interest rates on deposit accounts skyrocketed, reaching 16% in the early 1980s. That meant that all of a sudden, banks were having to pay much higher rates on their deposits than they were receiving on the 30-year loans they had made in previous years. If the banks had been able to lock in deposit rates for 30 years, the way home buyers could lock in the interest they paid on their mortgages, banks wouldn’t have had a problem. But they couldn’t. So they started losing money.

This mismatch between interest rates on mortgages that were fixed for 30 years and interest rates on deposits that were always changing led to another financial crisis—called the S&L crisis—because most of the banks that got into trouble were old savings and loan institutions that specialized in mortgage lending. Though that crisis wasn’t as bad as the 2008 one in its impact on our economy, it cost the government a lot of money and caused bank managers and regulators to look for ways to make sure it didn’t happen again. Securitization was meant to solve the problem. Once mortgages were made, instead of banks holding on to them, they would be pooled into securitizations and sold off to investors—investors like pension funds, life insurance companies, even retired people—who were happy to receive the same rate on their investment for many, many years. Banks could take the money they made by selling the loans into securitizations to make new loans at whatever interest rate was prevailing at the time.

This worked for a while, particularly when most mortgages were being originated by regulated banks and sold to government-created companies called Fannie Mae and Freddie Mac, which guaranteed the payments on the mortgage-backed securities. (More about Fannie and Freddie in Part 2.) However, it began to break down when big financial institutions started doing the securitizations without keeping any obligation to protect investors against loans defaulting. Once that happened, lending standards started to deteriorate and millions of mortgages were made that people couldn’t repay.

Then something called securitization happened, which dramatically changed the way people got home loans. With securitization, big financial institutions would pool together thousands of mortgages and put them into something called a trust. Investors—usually other big financial institutions like pension funds, insurance companies, and mutual funds—would pay for pieces of these trusts, which gave them the right to receive some of the loan payments. These pieces were called “mortgage-backed securities.” Because of securitization, money for the mortgages didn’t have to come from banks lending their deposits anymore. So lots of people got into the business of making mortgages.

Here are the basic steps in a mortgage securitization:

1) A person called a “mortgage originator” agrees to make a mortgage loan to Matt’s family.

2) The mortgage originator contacts a “securitizer”—usually a big bank or other financial firm—and lets it know that he has a mortgage to sell.

3) The securitizer, oftentimes working with a big bank, provides funds to the originator to make the mortgage, then puts it in a pool with other mortgages.

4) The loan payments on that and thousands of other mortgages in the pool are divided up into pieces called mortgage-backed securities and sold to other big institutions.

5) The securitizer uses that money to buy more pools of loans.



Securitization had some benefits. For one thing, it made more money available for mortgages so more people could buy homes. But it also created several problems. First, a lot of people who were not banks got into the mortgage-making business. The government heavily regulates banks that take deposits, and that is a good thing. A mortgage is a huge obligation for most families, and they should be borrowing money from responsible lenders who are overseen by the government. But with securitization, just about anybody could make a mortgage. A lot of these people weren’t really well trained, and there was no government agency watching them to make sure families were getting mortgages they could repay.

But even more importantly, the people arranging the mortgages didn’t have a reason to care if the borrowers could pay the loan back because they were just passing them on to big securitizers who were, in turn, selling interests in the loan payments to other big institutions. These “mortgage originators,” like the one that visited Matt’s family, were paid generous fees for arranging these mortgages up front. They figured out quickly, the more loans they made, the more they got paid, so they started originating as many as possible, without regard to whether people could pay them back. They didn’t have community ties in the same way as a traditional bank. And the big financial institutions who securitized and bought the “pieces” of these mortgage pools didn’t know the borrowers at all, so they didn’t feel the same commitment to them that a traditional bank might have.

Greed overtook the process, and mortgage originators started getting the idea that it was actually a good thing to make loans to people who couldn’t repay them, because that would force them to get another loan to pay off the unaffordable one. When a homeowner takes out a new loan to pay off the old one, it is called “refinancing.” These greedy originators started actively looking for people who were on tight budgets or people who were known to have had trouble in the past with managing their money. These people were called “subprime borrowers.” But they also targeted other vulnerable families, like Matt’s parents, who had responsibly managed their finances but were not sophisticated when it came to financial matters and had an immediate need for cash. Sometimes they would target entire neighborhoods, as was the case in the area where Matt lived. Boston was one of many cities throughout the country where unscrupulous mortgage originators targeted neighborhoods.

Most of the subprime borrowers, like Matt’s family, already owned homes and had mortgages with payments that they could afford and were fixed at the same amount over the entire 30-year life of the loan. Many middle- and low-income families had received their mortgages through a program run by a government agency called the Federal Housing Administration, or FHA. These were safe, affordable mortgages, but mortgage originators would actively seek these families out and convince them to take out new loans called “2/28s” and “3/27s.” Indeed, loans arranged through the FHA declined from 14% of all home purchases in 2001 to 3% by 2005. These families refinanced into loans being securitized by big financial institutions.

Most of these loans did not have fixed payments. Rather, after two or three years the payments on them would shoot up dramatically, usually to unaffordable levels, and could keep going up over the remaining years of the loan. This is why they were called 2/28s and 3/27s, because the payment was lower for the first 2 or 3 years, then shot up over the remaining 28 years (for a 2/28) or 27 years (for a 3/27) of the loan. To escape the higher payment, the homeowners would have to go back to the mortgage originator to get a new loan to pay off the old one, and that new loan would once again have a steep payment increase after a few years. Each time a family refinanced—that is, got a new loan to pay off the old one—the mortgage originator would get more money. The new loan would always be bigger than the old one to provide some extra cash to pay the mortgage originator and sometimes give the families something extra too—in Matt’s case, money to replace the roof.

This only worked so long as the family’s home was worth more than the amount of the new mortgage. If home prices kept going up, securitizers and the investors who bought mortgage-backed securities thought that it was okay to keep making bigger and bigger loans to subprime families. They figured that if the family stopped paying the mortgage, securitizers could just claim the house and sell it to get their money back. But home prices didn’t keep going up. They doubled from 2001 to 2006, but in late 2006 they started to decline. Now securitizers had a problem. They had made all of these big loans to borrowers whose houses were no longer worth more than the amount of the loan, and they didn’t want to lend them any more money. As a result, families like Matt’s who had mortgages with big payment increases could no longer get new loans to pay off the old ones. This is one of the reasons why so many people could no longer afford their mortgages and ended up losing their homes.

And the payment increases could be huge. Let’s say a family borrowed $150,000 on their house. A typical subprime loan in 2006 charged an interest rate of 9%, which would jump to 13% after two to three years. This worked out to a monthly payment of about $1,200 during the first few years, jumping to $1,650 after that. For families like Matt’s, who were already on a tight budget, they simply couldn’t keep up the payments. So the securitizer started a “foreclosure,” a legal process to take their homes away from them.

As of August 2013 about 6.75 million homes had been lost to foreclosure or sold by families facing foreclosure since the beginning of 2007. There were an additional million homes in the process of foreclosure, and another 2.1 million that were expected to enter foreclosure because the homeowners had not made mortgage payments for many months. About 10 million families are likely to lose their homes in the aftermath of the financial crisis. This represents about one in every five homeowners.

Having to give up their pets has been just one of the many bad consequences for these millions of families who have lost their homes. In Matt’s hometown of Boston, for instance, animal shelters reported a big jump in people giving up their pets because of financial reasons, including losing their homes to foreclosure. This put a real strain on animal shelters throughout the country. Most animal shelters are supported by donations, and as people were hurt by the financial crisis, they couldn’t afford to be as generous as they were in the past. So animal shelters were receiving less money to support their operations, even as more and more families were bringing their pets to them.