Countrywide accounting fraud and mortgage crisis

Countrywide Accounting Fraud

In the year 1969, David Loeb moved to NY from Virginia to begin a home loan and advance organization named as "United Mortgage Servicing." He was joined by his trusted aide Angelo Mozilo. Both shared common dreams of big money and making their presence felt across the nation. The sole owner of the firm, David Loeb had to, under pressure of work, circumstances and colleagues part with half of the ownership. David Loeb and Angelo Mozilo became equal partners of the new firm that they formed, "Countrywide." They began their operations from and opened their new office in California. Angelo Mozilo was a very forceful and opportunistic marketer, and began pushing for contracts in the market aggressively. The organization was chipping away at two fundamental boards; David's NY-based credit exercises and Mozilo's home loan plot trades in the city of California. After they attempted to present open share by coasting a stock in stock trade, David needed to move to Los Angeles. For about two years, the two carried on this formation and had a rather localized presence. By the year 1974 organization had begun an alternate eight business locales yet it was still a neighborhood player and much expansion and work needed to be done before their dream of being known across as "Countrywide" would be realized. (Chomsisengphet, & Pennington-Cross, 2006)

Before long, it was David Loeb who understood that some extraordinary measures ought to be taken to make organization to realize the inner desires. He chose to change whole staff and enroll new, highly skilled one with high pay. Mozilo was hesitant to such an extreme move however was persuaded to the imagination of the future possibilities wit a similar depiction of dreams that had brought them to the present from the modest past and upbringing. With, fresh recruits implanted, organization soon made huge benefits with the new thoughts put and actualized by new group. In the year 1978, organization was making astounding profits. It was not sheer hard work. Key to their prosperity was foresight in understanding and anticipating changes in investment rates before it happened accompanied by institutionalizing strategies (Chomsisengphet, & Pennington-Cross, n.d.).

Mozilo effectively snatched the opportunity with refinancing of homes as investment rates fell. Before long numerous property holders began to contribute with Countrywide for refinancing and by mid 1980s within 26 states it had 104 work places. 1984 to 1986 turned out to be the most happening for the organization as it topped a landmark figure of $3.2 billion. For initial 20 years, Countrywide registered development relentlessly and financial analysts were looking forward as the industry was hit by numerous money related and capital embarrassments. Countrywide, because of its clean image and considerable trust component, was favored by many investors and got a cushion of additional funds of over four hundred million dollars in late eighties & early nineties. The organization was sufficiently shrewd to peruse the technologically advancing times and immediately acquainted itself with new technical skills with minimum expense and application handling time for the clients. For 1990, as a matter of example, the association displayed its own state- of-the- art workmanship development start-up organization, EDGE, through which it was proposed to decrease the dangers of deficient credits and affirmation evaluating (Chomsisengphet, & Pennington-Cross, n.d.).

The system had limited, by and large lessened expense by taking care of costs, while stimulating financing time to a period of less than 30 days on standard home loans, by engaging development specialists to enter customer information simply once. Typical information could then be copied to diverse records hence; figures, for instance, credit rates and refund centers could be downloaded similarly. EDGE then printed out completed genuine copies of all chronicles on a laser printer, discarding the prerequisite for preprinted development structures and saving the association $1 million a year (Chomsisengphet, & Pennington-Cross, n.d.).

Countrywide upheld its dedication to this industry by promising to offer $5 billion in House-America kind of credits to the country's two biggest home loan banks, the Federal National Mortgage Association, "Fannie Mae," and the Federal Home Loan Mortgage Corp., "Freddie Mac," both of which were made by Congress to guarantee that moneylenders have a consistent wellspring of cash for home loans. Plans to enter into money market funds, stocks, no-load mutual funds, annuities and in 1996 also contributed to the company's prediction of yearly earnings of more than $300 million by the end of the decade. (Chomsisengphet, & Pennington-Cross, 2006).

The Transgressions and the transgressors

Without conventional capital requirements on the scale of home loan loaning exercises, Countrywide's exercises extended quickly from 2000 onwards. The main features of the mortgage loans originated by Countrywide during the boom years also changed. The relative decrease in office credits and increment in non-organisational advances was risky from a profitable management point-of-view in light of the fact that the non-organization advance business was less fluid. Very much in contrast to non-office credits, the agency advances must meet certain criteria, for example, most extreme advance to home value proportion, greatest obligation to salary degree, and a certain level of home loan documentation. To expand the capital accessible for home advances, the business sector for office credits is supported by government supported infrastructure by way of norms, and regulations. This manifested in decrease in credit quality of Countrywide mortgage activity. This actually added a huge risk factor and contained within it a likely cause for downslide of the organization (Freeman, Wells, & Wyatt, 2013)

This possibility of increasing danger being taken by Countrywide was possibly understood in the financial media sector as possibly early as 2004, when Countrywide was recognized as a forceful loan specialist in the more hazardous domains of the home loan market, and the media expressed worries about the helplessness of Countrywide to provide the much needed strength to the U.S. home-loan market. Thus came into being first major alteration that Countrywide undertook . Countrywide had entered into riskier domains of initializing mortgages and subsequently securitization. Although, this possibly, was the main cause of the shipwreck. The second major and consequent (to the first) was that the financial statements did not explicitly state the risk the company was exposed to. Lastly, it was apparent that the CEO of the company was privy to information that he should have divulged, ad he failed at that. (Tam, Q, 2012).

It was also noted that the Equal Credit opportunity Act (ECOA) was also violated by Countrywide. ("USDOJ: U.S. Attorney's Office - Central District of California,")

The market was on an upswing beginning 2000 through 2006 and hence was oblivious to the undercurrents as also some obvious facets of the mortgage market. Real estate market was exceeding its limits and government was largely ignorant about manipulations of its credit rating policy. Borrowers were given a free hand to declare their state of difficulty and sell their property to make profits. The Problem was realized quite late when average market cost of the property fell by a whopping twenty six percentage points and the obvious result was that these defaulting borrowers were stuck deeply into the debt-cycle, unable to find a way out of the rut. The most significant time in the default context was in the year subsequent to origination, and across the nation, the foreclosure rate on subprime mortgage loans originated during 2006 was more than 10 per cent in during the entire year and upto September 2007, and in some states (such as California) it topped 20 per cent (Chomsisengphet and Pennington-Cross, 2006; Demyanyk and Hemert, 2008).

This led to Countrywide's mortgage originations falling 11.2 per cent in 2007 (from $468.17 billion to $415.63 billion). (Michael Hudson, 2011) As if it was not sufficient, Countrywide made a recourse to its mortgage loan policy and started writing lower yielding agency loans GSEs would securitize and purchased it. This had the result that Countrywide's avenues and even caps of the "higher default risk" non-agency mortgage originations fell 42 per cent in just one year, from a holding of $305.98 billion in 2006 to $176.42 billion in 2007. With the increasing reduction in investor appetite for higher yield, mortgage securitized bonds (arising from the securitization of non-agency mortgages loans), liquidity soon started posing problems for Countrywide. (Michael Hudson, 2011). Situation soon became untenable for Countrywide and they chose to seek a bailout by yielding to Bank of America 7.25% of its shares. All this happened in August 2007 and by October 2007, its subprime transactions were under the investigations of SEC. In January 2008, Bank of America offered rescue deal that Countrywide had to accept to avoid bankruptcy.

The laws, rules, ethics that were violated by the fraudster(s)

From 2000 onwards until 2006 company showed extraordinary and almost unnatural growth in its profit growth. The major component of this runaway trajectory was 'gain on the sale of loans and securities', which reached $5,681.85 million or almost half of its total accruals in 2006. There was a non-linear correspondence between loan quality and profit margin. In addition to that, loans were not clearly marked into divisions of 'risked loans' and 'no risk loans'. Therefore, when the company was getting huge profit from loans it actually was achieving it because of 'risked loans'. The directors of the company were very well aware of this fact but chose to keep it at abeyance and never mentioned in their balance sheets. ("The Sarbanes-Oxley Act 2002,")

The upswing in profit margins and hence growing possibility of delinquency and foreclosure rates are definite pointers of the risk value of the loans. However, this risk was camouflaged in the financial statements of the company, meaning the company was all the while aware of it, and chose to hide behind its manipulated and profess that all was under its control., thereby revealing very less of its actual riskiness. The unnatural growth of Countrywide was because of its unethical stance of creating high yield securitized mortgage loans. In as much as securitization helped Countrywide to expand its horizons of activity, at the same time it also enabled the company to accelerate its valuation in the public as well as financial markets. Very little attention was drawn towards the abrupt growth in interest accruals by the company nor was the more dubious mortgage service fee revenue noticed by financial analysts.

The capital which company garnered under the head of securitization transactions were strikingly attractive and if investors or analyst had been vigilant enough to notice it, the manipulations of the company would have been exposed right at the beginning stage of its fraud. Even as there were clear pointers that Countrywide was exposing itself to significant risks, a question mark appears whether these risks were explicitly exhibited in the financial statements. Countrywide made attempts and did try to clearly state and repair damage in its activities by engaging in discussions on credit risks but it there was a general air of secrecy maintained around the quantum and about its magnitude.

In 2007, credit losses of $1,283.10 million were brought to book, and whereas this is itself quite a problem in itself, the evaluation and acceptance of built-in guarantees through representative agents and securities and financial tools and warranties towards the quality of mortgages being securitized was becoming more evidenced. As the non-payments and defaults on mortgage loans held by Countrywide started increasing, they started triggering the buyers of the securities to claim withdrawals that they held in these warranties and representations. To understand the quantum of this problem it is indicative in the company's liability for warranties and representations, which rose by 64 per cent in 2007, to $639.64 million from $390.11 million. The additional portfolio of home loan advancing dangers at the peak of the business had massive and tangible gains for the company.

As the economy as a whole turned southward, and home loan investment rates started going up, the number of mortgage holders unable to keep paying their installments started to climb. Additionally as the prices started falling, many holders were unable to sell off their houses and avoid abandonment. Even as this was happening, many home loan holders were in arrears even prior to their advantage rates reset. And add to that the fact that there was a huge amount of lending that was fraudulently made available to the public in the quest of the now acute liquidity crunch (Olster, 2013).

A whistle blower, Eileen Foster mad this fact public in a TV. Foster was a senior official in Countrywide and later appointed as the investigative officer for any breach and wrongdoing in Countrywide. (Tam, 2012) She was to find out that the frauds went to the extent of forged documentation and even signature forgery by employees of countrywide only to keep selling as much as possible at the highest rate, even if at higher risk (Olster, Scott, 2013). The main problem here was that the management was aware of this fraudulent activity and did nothing, rather encouraged it by not reporting the matter to the authorities. This was clearly a violation of the SOX law (U.S. Foreign and Corrupt Practices Act 1977 (FCPA)).

The role of CEO

Angelo Mozilo was with the company as one of its founder member, and had risen to become its CEO. As such, he had the most of the more intricate workings within and influence on the path the company eventually traced. He was among the most highly paid, in fact sixth, executive in the country according to Corporate Library LLC. He was obviously deeply involved and had probably influenced or at least given a go-ahead to the 'risked' loans portfolios but chose not to make the matters explicit in the financial statements and balance sheets.

It is unnerving to note that when the company was under duress, Mozilo got a huge compensation amount. The intentional side-stepping resorted to by the CEO in the face of fact hiding tactics adopted by Countrywide are indicative of the possibility that the huge returns that he personally was to gain were causative of his dereliction of duties and thereby ethics of business. It was only right then, that he was brought to book and put on trial in 2009 but was surprisingly acquitted and even a formal charge was not framed against him. The fine he was supposed to pay amounted to a few million dollars that he paid readily to avoid a more damaging in-depth inquiry into the dealings of the company that would have bared open the multitudes of financial over-stepping and even transgressions of ethical business practices.

The impact on affected stakeholders

The target of this paper is to give a fleeting insight into the causes for the 2007 -- 2010 money related problems and advice the administrative impartial discussion that ensues. Reporters differently found out faults in the budgetary emergency on money related reporting inconsistencies, securitization and unethical credit practices, unchecked exchange of securities, (for example, OTC exchange mechanisms of home loan backed securities and credit default swaps), and the eventual fall of the land market.

To serve as a guideline to this civil argument we chose to study the problem from many angles and analyze the working style adopted by Countrywide, an organization exhibiting how a large portion of the business practices apparent in monetary establishments in the years leading towards a crash in the market. Due emphasis has been given to investigating Countrywide as it was amongst the first firms to breakdown amid the monetary emergency, yet preceding the emergency had risen metamorphically into the biggest player in the U.S. home loan credit market. To restate emphasis, in the period 2000 -- 06, Countrywide originated $2.21 trillion in home loan credits out of which as much as $2.19 trillion were in securities. From these exercises of securitization, Countrywide created as much as $27.25 billion that formed the dominant part (58.3 every penny) of the income of organization.

The organization's dubious securitization practices also brought about an exponential rise in wages - $2,674.86 million in 2006 from a modest $374.15 million in 2000. However immediately and equally abruptly, in the second half-year of 2007 Countrywide's value crashed evidently without any cautioning and liquidation was just about avoided when the company agreed a four billion merger with Bank of America in January 2008. This study demonstrates that Countrywide embarked on a plan of action of starting and securitizing home loan credits that was, however just about reasonable because the property estimations were encountering value additions. This strategy was also in parts supported by policy approvals that inadvertently paved way to low quality home loan credits.