16 cents on the dollar: Doing the math on Mozilo settlement

Introduction

In the end, Angelo Mozilo settled for pennies on the dollar.

The former Countrywide Financial Corp. chief agreed Friday to a settlement that requires him to pay 16 cents out of his own pocket for every dollar federal authorities claimed he had taken out of the company in ill-gotten personal gains.

The math works like this:

• The government alleged that he added $141.7 million to his personal fortune through fraud and insider trading.
• Mozillo agreed to personally pay a $22.5 million fine – 16 percent of the alleged ill-gotten gains.
• In addition, Mozillo agreed to turn over another $45 million to former Countrywide shareholders, who lost billions when the company’s stock price plummeted as loan defaults soared. But the $45 million won’t come out of Mozilo’s pocket. Under the terms of his employment contract, it will be paid instead by Countrywide’s insurers and by Bank of America, which bought Countrywide in 2008.

The government settled for less than it wanted because, one legal analyst said, because it would have been a challenge to prove its case.

“This is not a slam dunk,” Duke University law professor James D. Cox told the New York Times. “It’s a risky case and it’s got a lot of complexities to it.” Mozilo admitted no wrongdoing, and his lawyers were sure to have mounted a ferocious defense.

The Securities and Exchange Commission said the $22.5 million fine will be the largest penalty ever paid by a senior executive of a public company in an SEC settlement.

Too easy?

But some observers wonder whether Mozilo got off easy.

David Callahan, author of the book, The Cheating Culture: Why More Americans Are Doing Wrong to Get Ahead, writes at the Huffington Post: “It is hard to see how the Mozilo settlement – coming on the heels of another weak SEC settlement with financier Steve Rattner – will deter future wrongdoing… Indeed, it could have the contrary effect. If you can make a great fortune behaving badly, get busted, and still end up with most of that [fortune], then you’ve come out way ahead. At least in financial terms.”

Countywide reaped huge profits – and, eventually, produced huge losses for its shareholders – through a high-wire strategy that focused on pumping up its volume of subprime loans and other risk products. Countrywide ranked No. 1 among the 25 top U.S. lenders which made subprime loans from 2005 through 2007, according to the Center for Public Integrity’s Who’s Behind the Financial Meltdown?

One of the ironies of Countrywide’s fall was that Mozilo had been hesitant, at first, to jump into the subprime market. As I write in my new book about the subprime debacle, The Monster, Mozilo and Countrywide eventually succumbed to the temptation to follow the example of Ameriquest Mortgage Co. and its billionaire owner, Roland Arnall, an entrepreneur who was in many ways the founding father of subprime.

The inventive mortgage products emerging in the home-loan market were watched closely by the heaviest of the industry’s heavyweights: Countrywide Financial’s Angelo R. Mozilo. Mozilo’s company had established itself as the largest mortgage lender in America by providing loans to home owners with good credit. Mozilo called his company “my baby.” For much of his career, he had been cautious about the kinds of loans his company made. Countrywide had mostly steered clear of subprime as other lenders dived into the market throughout the 1990s. Mozilo worried that subprime loans were too risky, in some cases even “toxic.”

Yet as Ameriquest and subprime expanded, Mozilo became fixated on Roland Arnall’s success, according to Paul Muolo, an editor at National Mortgage News who interviewed Mozilo many times over the years. The two moguls met in the early 2000s, each trying to size up the other. Arnall wanted to surpass Mozilo as the biggest mortgage lender of any type. Mozilo wanted to know the secret of Ameriquest’s runaway growth. Mozilo could see that Arnall’s company was a giant sales machine, driven by bonus- hungry loan officers who used “stated-income” loans and other risky products to aggressively increase thecompany’s market share. “He plays by his own rules,” Mozilo said. “He’s the guy who started stated-income, the guy who started no documentation loans. All of his people were on commission.” Mozilo learned more about Arnall’s tactics after Countrywide hired a group of former Ameriquest employees in New York. He was so concerned by what he heard, he said, that he forwarded the information to the state’s attorney general, Eliot Spitzer.

While Ameriquest’s methods may have made Mozilo uneasy, he wasn’t so troubled that he kept Countrywide from joining the subprime gold rush. His company had survived decades of real-estate booms and busts, and he thought it had the brains and brawn to handle the risks of subprime better than the upstarts. Mozilo’s competitive instincts beat out his caution. He couldn’t accept being second or third. “It’s a question of dominance,” he told investors. He didn’t like that Countrywide trailed Ameriquest in the subprime lending rankings. By 2003 Arnall’s companies had captured nearly 12 percent of the subprime market; Countrywide did barely half as much subprime volume, with a market share of just 6 percent.

Besides, the real money in the mortgage business was now in subprime, not in prime loans. When Countrywide sold prime loans to investors, its average profit margin was 0.93 percent; when it sold subprime loans to investors, the company’s profit margin nearly quadrupled, to 3.64 percent. The fees, interest rates, and prepayment penalties embedded in subprime loans made them much more seductive to investors.

Countrywide’s size, clout

Though Mozilo’s company came late to the party, once it was there, its size and clout deepened the pain that subprime visited upon home owners and the financial system. Countrywide did little to pull back on its subprime push, even in 2006, when there were signs of an impending crash. “You have to make a choice — to get out or not. And they stayed,” a longtime mortgage industry watcher told the Los Angeles Times. “It’s hard when you’re following someone off a cliff to know when to stop.”

In early 2008, Bank of America purchased Countrywide, once worth as much as $26 billion, for a fire-sale price of $4 billion.

Countrywide might have survived if its founder hadn’t become fixated on competing with Ameriquest, according to Muolo, the National Mortgage News editor. “If he hadn’t followed Roland Arnall down the subprime path this would never have happened,” Muolo said. “It’s ego and ambition that sunk him.”