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 FINANCIAL CRISIS INQUIRY COMMISSION REPORT

less sophisticated regulator than the Federal Reserve.”  In August , Mozilo
wrote to members of his executive team, “It appears that the Fed is now troubled by
pay options while the OTS is not. Since pay options are a major component of both
our volumes and profitability the Fed may force us into a decision faster than we
would like.” Countrywide Chief Risk Officer John McMurray responded that “based
on my meetings with the FRB and OTS, the OTS appears to be both more familiar
and more comfortable with Option ARMs.” 
The OTS approved Countrywide’s application for a thrift charter on March ,
.

LEVERAGED LOANS AND COMMERCIAL REAL ESTATE:
“YOU’VE GOT TO GET UP AND DANCE”

The credit bubble was not confined to the residential mortgage market. The markets
for commercial real estate and leveraged loans (typically loans to below-investment-
grade companies to aid their business or to finance buyouts) also experienced similar
bubble-and-bust dynamics, although the effects were not as large and damaging as in
residential real estate. From  to , these other two markets grew tremen-
dously, spurred by structured finance products—commercial mortgage–backed se-
curities and collateralized loan obligations (CLOs), respectively—which were in
many ways similar to residential mortgage-backed securities and CDOs. And just as
in the residential mortgage market, underwriting standards loosened, even as the
cost of borrowing decreased,  and trading in these securities was bolstered by the
development of new credit derivatives products. 
Historically, leveraged loans had been made by commercial banks; but a market
for institutional investors developed and grew in the mid- to late s.  An “agent”
bank would originate a package of loans to only one company and then sell or syndi-
cate the loans in the package to other banks and large nonbank investors. The pack-
age generally included loans with different maturities. Some were short-term lines of
credit, which would be syndicated to banks; the rest were longer-term loans syndi-
cated to nonbank, institutional investors. Leveraged loan issuance more than dou-
bled from  to , but the rapid growth was in the longer-term institutional
loans rather than in short-term lending. By , the longer-term leveraged loans
rose to  billion, up from  billion in . 
Starting in , the longer-term leveraged loans were packaged in CLOs, which
were rated according to methodologies similar to those the rating agencies used for
CDOs. Like CDOs, CLOs had tranches, underwriters, and collateral managers. The
market was less than  billion annually from  to , but then it started grow-
ing dramatically. Annual issuance exceeded  billion in  and peaked above
 billion in . From  through the third quarter of , more than  of
leveraged loans were packaged into CLOs. 
As the market for leveraged loans grew, credit became looser and leverage in-
creased as well. The deals became larger and costs of borrowing declined. Loans that
in  had paid interest of  percentage points over an interbank lending rate were