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October 20, 2010
SEC Settlement with Countrywide Executives: A Template for Personal Liability?
    by Robert Kropp speaks with Laura Berry of the Interfaith Center on Corporate Responsibility about shareowner engagement addressing subprime lending that stretches back to the 1990s. Second in a two-part series.

Books addressing the financial crisis are being rushed to market in increasing numbers, and many of them tout the prescience of Wall Street insiders who foresaw the collapse of the subprime mortgage lending market. With the closing of one small chapter of the story occurring last Friday, when the Securities and Exchange Commission (SEC) settled its charges against former executives of Countrywide by leveling the largest penalty ever for a senior executive against former CEO Angelo Mozilo, it seems appropriate to consider the role of the faith-based investors at the Interfaith Center on Corporate Responsibility (ICCR) in calling attention to issues now associated with predatory lending practices.

As described in the first part of this series, the loans devised by predatory lenders such as Countrywide became unaffordable to many low-income borrowers, and refinancing was impossible for them. When the economy collapsed, and the persistent high unemployment followed, record numbers of defaults on such loans resulted.

"Whether it's underwriting practices that go back to the mid-nineties, or securitization practices in the late nineties, or the recent emphasis we had this last season on asking companies to report on policies for collateralization of their derivatives, why were we there so early?" Laura Berry, Executive Director of ICCR, asked in a conversation with "It goes to the core of what faith-based investors are called to do. We navigate the space between rational action in a flawed world and what our faith traditions call us to do."

Following the passage in 1977 of the federal Community Reinvestment Act (CRA), which required banks to lend money in local communities, subprime mortgages, designed to provide credit to low-income borrowers, became more common. According to an article published by ICCR, entitled The Buck Stops Here: How Securitization Changed the Rules for Ordinary Americans, the market for subprime and other unconventional mortgages grew from $136 billion in 2001 to $1.2 trillion in 2005. Furthermore, the percentage of subprime borrowers who did not document assets or income grew from 17% in 2000 to 44% in 2006.

As the ICCR article pointed out, subprime mortgages "are necessary, even laudable, under some circumstances. After all, not everyone has perfect credit and many cannot come close to buying a house with a 20% down payment that would gain favorable interest rates. Subprime mortgages can…give low-income applicants with less-than-spotless credit histories access to home ownership when conventional mortgages would be otherwise unavailable."

Well before subprime mortgage lending began to get out of hand, ICCR members were questioning the practices of financial institutions that provided such loans. As far back as 1993, ICCR members filed six shareowner resolutions requesting that lenders more closely regulate the underwriting practices for such loans.

By the early nineties, "There was a convergence of policy initiatives, easy credit, and underwriting practices that were suspect," Berry told "With access to a huge pool of available data, we could ask, what happens if unjust practices affect the business models of the companies we own?"

ICCR's call for closer monitoring of underwriting practices went largely unheeded, as did its call for securitization practices later on. By securitizing mortgage loans, banks no longer had to concern themselves with whether or not a loan is repaid, leading, as Harry Van Buren of the Episcopal Church described it, to "perverse incentives for banks to extend credit without regard to whether it can be paid back."

Securitization of mortgage loans, or the bundling of loans into financial products, was a first step toward the creation by financial institutions of increasingly complex instruments that were a major cause of the financial crisis. After years of attempting to convince financial companies to disclose the manner in which they collateralized derivatives, only to have the resolutions disallowed by the SEC, ICCR members were successful in 2010 in having resolutions requesting that financial institutions "ensure that the collateral is maintained in segregated accounts and is not rehypothecated." Rehypothecation refers to the practice by financial institutions of taking in collateral as guarantees on derivatives trades, and then using it as collateral for their own transactions.

Addressing the increasing complexity of financial instruments, Berry said, "Once you turn the proper role of capitalism, which is allocation of capital, into a gambling casino by betting on the bets you are making, it's extraordinarily hard work to recover from the pillaging of the capital markets."

As an example of the unintended consequences of such activities, "Futures markets used to serve two purposes, currency hedging and commodities hedging for manufacturers," Berry said. "What's now happened is that the hedges themselves have become highly liquid and traded financial instruments. We're driving instability in pricing structures that are creating even bigger problems for the poorest people in the world."

"The regulatory environment, which was not integrated and not sustainable, has not figured out how to manage the new financial instruments that have been created in the derivatives markets," Berry continued. "This spiraling away from just and sustainable practices is the reason why ICCR members have been engaged in the regulatory and policy environments."

Berry sees in the SEC settlement with Mozilo and two other Countrywide executives evidence that regulators are finally catching up with the complex financial instruments introduced into the markets over the past few years.

"A couple of things have been heartening about the actions the SEC has taken. First of all, there was so much greed and pushing of the regulatory envelope," she said. "The SEC is starting to tell corporate leaders that this isn't a systemic failure that taxpayers have to pay for. This isn't even a failure that the corporation needs to pay for. The SEC action is about identifying personal leadership liabilities."

"You were in charge, and you made the decisions. You need to be punished," she added. "Let the regulators judge if the penalties are appropriate."


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