Oct 09, 2008

Top Nominees for Charity Bail Out Benefactors

by Laura Starita

Last week my colleague Tim Ogden asked rhetorically who would bail out the nonprofit sector in the likely event that 2008 philanthropic donations fall drastically. In the interest of debate I’d like to open up the nominations by naming Herb and Marion Sandler as my top pick for creating a non-profit bail-out fund.

Followers of the financial crisis may know the Sandlers as the husband-and-wife team behind Golden West Financial. In 2006 Golden West was the second largest savings and loan in the United States, behind Washington Mutual. Its growth as a company was largely fueled by the marketing of Option adjustable rate mortgages (Option-ARMs) to the masses—an innovation generally credited to the Sandlers who called them “Pick-A-Pay” loans. These loans, in contrast to traditional mortgages, give borrowers an option regarding how much to pay each month. Each month the borrower could pay the standard payment—exactly as they would with a normal 30 year mortgage, just the interest due, or even less than the interest due, with the shortfall added to the mortgages principal. Unlike subprime loans, which are targeted toward people whose income and behavior is considered ‘high risk’ from a banking perspective, these types of mortgages were originally a niche product only for the very wealthy who bought and sold second and third homes on a frequent basis. In those cases, it made little sense for borrowers to make standard principal plus interest payments—the borrowers were going to sell in very short order and could afford to take on the risk that the value of a vacation home might decline. In theory, these mortgages also make sense for people who expect their incomes to rise substantially—they may not be able to afford the standard principal and interest payment in the first few years they live in the home but will be able to do so as their income increases. One study conducted by Columbia University economists argued that it is the ‘best’ loan type for a market in which consumers behave rationally. That rational behavior means that people pay according to their liquidity. In flush times people pay the maximum possible, in lean times they pay the minimum.

Of course, that’s not how Pick-A-Pay mortgages were really marketed and sold. A reported eighty percent of Option-ARM loan holders pay only the minimum amount every month, which means that the borrower owes more as each month passes. The consequence in these current times of falling housing prices—particularly in California, Nevada and Florida which have had some of the worst drops in home value, and where more than 70 percent of these loans were originated—is that the amount owed on the loan very quickly exceeds the total value of the home. To make matters worse, the ARM part of the Option-ARM means just that: the interest rate adjusts with the market, so what may have started as a two percent interest rate, offered in order to entice the borrower and close the sale, becomes an eight percent interest rate or higher. Oh, yes, and there is something else: one does not get to pay the minimum indefinitely. Once the loan exceeds a certain value in relation to the home price, the loan defaults to a maximum payment/maximum interest rate. So what may have started as a $1000 a month payment suddenly becomes $3500. On an individual level, this is how ninety-year-old women, former Army vets, and middle class working fathers of five, all with formerly strong credit, suddenly can’t meet their monthly payments and get evicted. This is how tens of thousands of people who would never have been considered high risk before suddenly become indistinguishable from the sub-prime customers who were blamed for the first round of defaults and failures seen last year. And this is also how world governments approve multi-hundred-billion-dollar bail-out packages, because the collective impact of billions in defaulted loans suddenly threatens the liquidity of even the world’s most stable banks.

So where do the Sandlers fit in? Herb and Marion created the loan instruments that allowed thousands of Americans to purchase homes they could not afford, and then sold the fruits of their labor in 2006 to Wachovia for more than $24 billion, netting a $2.4 billion payout for themselves. With the acquisition, Wachovia acquired Golden West’s $122 billion dollar portfolio of Pick-a-Pay loans, which most analysts point to as one of the major reasons why Wachovia, for all intents and purposes, failed last week. More relevant to our purposes, however, is the fact that, according to an article published in the New York Times Magazine earlier this year, the Sandler’s funneled around $1.4 billion of that take into the small foundation from which they had been making donations for years, and began pursuing larger philanthropic projects. Some of their main initiatives, from before and after the Wachovia sale, have included the Center for Responsible Lending, a think tank dedicated to putting an end to predatory lending practices, and ProPublica, an organization whose aim is to promote investigative journalism—specifically corporate malfeasance. What are the odds that ProPublica is currently investigating the Sandler’s personal role in developing and marketing Pick-A-Pay loans?

The Center for Responsible Lending is an interesting place to hover for a minute. The organization markets itself as a resource for “predatory lending opponents”, and it is taking on such practices as sub-prime lending, pay-day lending, overdraft loans and refund anticipation loans, among other things. All of these services are targeted specifically to the poor and charge extremely high interest rates on small amounts of money distributed in times of need. In essence, they are geared toward people with limited options, and often result in further accrual of debt and downward spiraling into poverty. In the Times Magazine piece about the Sandler’s philanthropic activity, they said:
“It starts with outrage,“ said Herb. “You go a little crazy when power takes advantage of those without power. It could be political corruption — ”
“Or subprime lending,” Marion interrupted.
“The story of subprime is worse than anyone has written so far,” Herb said, shaking his head in dismay.
“It is,” Marion said, nodding in agreement.

So where’s the outrage, Mr. and Mrs. Sandler, at the way in which your own Pick-a-Pay invention has allowed thousands of people to acquire more debt than they could reasonably pay off? It doesn’t matter that they started out with good credit. Allowing a person with a solid credit rating and a $130,000 annual household income buy a home he cannot afford is just as irresponsible and exploitative as allowing someone with bad credit and $30,000 a year in income buy a home he can’t afford.

The Sandlers don’t seem to see the connection. This past weekend Herb went on the record again after a Saturday Night Live send-up named him and Marion as “people who should be shot.“ In an AP interview published Monday he defended Golden West and the Pick-a-Pay portfolio, asserting that the assets Wachovia purchased are “outperforming” their competitors and will not result in the $12 billion in losses that are estimated, a point he also made earlier this summer in the Wall Street Journal. This view is not far from where the Sandler’s sat two years ago during the Wachovia acquisition, when an American Banker article quoted Herb as saying that “regulators talking about option ARMs ‘confuse the product with the underwriting of the product, which is just silly.‘“ Given that Marion Sandler was Vice President of Marketing for Golden West until it was sold to Wachovia, that sounds a bit like blaming the soldier for carrying out the orders of the general.

So back to that nonprofit bail out. If the philanthropic short-fall hits 10 percent of total giving, which currently seems to be the worst case scenario, that translates into a one-year loss of $30.6 billion, crudely calculated from the $306 billion in philanthropic capital donated in 2007 according to Giving USA. We would be the last to argue that all nonprofits are worth rescuing, but some are. So since the Sandler’s were prime beneficiaries of the bubble that is now bursting, how about they create a nice 8 percent kitty to back-up the best of them, a $2.4 billion bail out package to underwrite the most effective organizations that are now going to have to provide human services to far more people than ever should have needed them.