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SUMMER : DISRUPTIONS IN FUNDING
Committee members discussed the “considerable financial turbulence” in the sub-
prime mortgage market and that some firms, including Countrywide, were showing
some strain. They noted that the data did not indicate a collapse of the housing mar-
ket was imminent and that, if the more optimistic scenarios proved to be accurate,
they might look back and be surprised that the financial events did not have a
stronger impact on the real economy. But the FOMC members also expressed con-
cern that the effects of subprime developments could spread to other sectors and
noted that they had been repeatedly surprised by the depth and duration of the dete-
rioration of these markets. One participant, in a paraphrase of a quote he attributed
to Winston Churchill, said that no amount of rewriting of history would exonerate
those present if they did not prepare for the more dire scenarios discussed in the staff
presentations.
Several days later, on August , Countrywide released its July operational
results, reporting that foreclosures and delinquencies were up and that loan produc-
tion had fallen by during the preceding month. A company spokesman said lay-
offs would be considered. On the same day, Fed staff, who had supervised
Countrywide’s holding company until the bank switched to a thrift charter in March
, sent a confidential memo to the Fed’s Board of Governors warning about the
company’s condition:
The company is heavily reliant on an originate-to-distribute model, and,
given current market conditions, the firm is unable to securitize or sell
any of its non-conforming mortgages. . . . Countrywide’s short-term
funding strategy relied heavily on commercial paper (CP) and, espe-
cially, on ABCP. In current market conditions, the viability of that strat-
egy is questionable. . . . The ability of the company to use [mortgage]
securities as collateral in [repo transactions] is consequently uncertain
in the current market environment. . . . As a result, it could face severe
liquidity pressures. Those liquidity pressures conceivably could lead
eventually to possible insolvency.
Countrywide asked its regulator, the Office of Thrift Supervision, if the Fed could
provide assistance, perhaps by waiving a Fed rule and allowing Countrywide’s thrift
subsidiary to support its holding company by raising money from insured deposi-
tors, or perhaps through discount-window lending, which would require the Fed to
accept risky mortgage-backed securities as collateral, something it never had done
and would not do—until the following spring. The Fed did not intervene: “Substan-
tial statutory requirements would have to be met before the Board could authorize
lending to the holding company or mortgage subsidiary,” staff wrote. “The Federal
Reserve had not lent to a nonbank in many decades; and . . . such lending in the cur-
rent circumstances seemed highly improbable.”
The following day, lacking any other funding, Mozilo recommended to his board
that the company notify lenders of its intention to draw down . billion on backup
lines of credit. Mozilo and his team knew that the decision could lead to ratings
