Who's to blame for the mortgage mess?

By Michael Brush

It's not over, folks. There's plenty of pain left to come for homeowners and investors already battered and bruised by the subprime-mortgage meltdown.

Consider that analyst Mike Mayo of Deutsche Bank predicted Monday that worldwide losses from bad subprime-mortgage loans will reach as much as $400 billion. To date, reported losses are less than a quarter of that total. And market strategist Ed Yardeni on Monday doubled the odds of recession in 2008, to 30%.

But even if we don't know when it will end, we're getting a much better idea of whom to blame. It's a collection of regulators, Wall Street titans and too-smart number crunchers who were supposed to be providing adult supervision. Instead, they chose either to enrich themselves or to look away as others did. Below is a rundown of the worst offenders.

No. 1: Alan Greenspan

In his best-selling book, Alan Greenspan describes how well he managed the economy during an "age of turbulence." Unfortunately, he's largely responsible for the current dose of it.

As chairman of the Fed, Greenspan took the federal funds rate down to 1% in 2003 and left it there for a year. Even as the Fed began raising rates, Greenspan's exceptionally low interest rates "planted the seeds for the housing bubble," says Robert Rodriguez, a money manager at First Pacific Advisors who saw the emerging subprime mess early on and has managed to dodge most of it so far.

• Talk back: Who do you think is really responsible for the subprime mess?

Greenspan's role in the current mess doesn't stop there. He encouraged the use of adjustable-rate mortgages in a 2004 speech, which was "an insane, idiotic recommendation," says Rodriguez. The following year he endorsed subprime loans to help marginal borrowers get into houses. And true to his somewhat naive brand of Ayn Rand libertarianism, Greenspan dismissed calls for more oversight of the mortgage business. This gave free rein to our next culprits: greedy mortgage brokers who had no problem pushing inappropriate loans on borrowers so that they could reap lucrative fees.

No. 2: Countrywide CEO Angelo Mozilo

None of this would have been possible without the help of mortgage lenders willing to go along with the charade. There are many of them, but I'd cite Countrywide Financial (CFC, news, msgs) CEO Angelo Mozilo as one of the most egregious.

Mozilo acknowledged potential risks in the subprime market early on, but he continued to compete to maintain market share, even though the only way to do this was to water down loan underwriting standards like everyone else. "If the market was offering something, they wanted to offer it too," says Erin Swanson, a Morningstar (MORN, news, msgs) analyst who covers the stock.

Even though Mozilo made more than $20 million a year in salary and bonuses in 2004 and 2005, he wanted to book more profits, mainly by selling stock options, as Countrywide was riding high on the bubble. We know this because he took advantage of a special rule to set up an automatic selling program in his company's stock. Company documents show he realized $310 million in the three fiscal years ending in June 2007. If his agenda was to cash out personally, he had a good motive to play along with the subprime charade.

Countrywide declined to comment, but a company spokesman has told other media outlets that no one, including Mozilo, could have foreseen the events that led to the current problems with subprime-mortgage debt and that all of Mozilo stock sales complied with regulatory rules.

No. 3: Christopher Ricciardi

Mozilo and the rest of the subprime lenders couldn't have underwritten all those dodgy home mortgages without having a way to sell them and get them off their books. In this effort, they got a hand from our next culprits: the crafty bankers who created a Wall Street debt machine that repackaged subprime loans so they could be sold to investors.

An investment banker named Christopher Ricciardi helped turn Merrill Lynch (MER, news, msgs) into the "Wal-Mart of the CDO industry" between 2003 and 2006, according to The Wall Street Journal. Ricciardi "lobbied both credit-rating firms and investors, talking up the safety and juicy returns of CDOs," the Journal says. Ricciardi has since left Merrill, which on Oct. 24 reported a $7.9 billion write-down related to its collateralized debt obligations.

Even if then-Merrill Chief Executive Stan O'Neal missed the subprime losses because they were too far down in the chain of command, he obviously knew about the First Franklin acquisition last January. First Franklin specialized in offering subprime mortgages to borrowers with poor credit histories. Merrill purchased the operation to get more exposure to subprime lending -- just before the business was about to turn sour. So he shares the blame for Merrill's role in the subprime debacle. He admitted this in a 20-minute video message to employees before leaving the bank.

No. 4: Ralph Cioffi and Jim Kelsoe

The masters of the CDO universe on Wall Street couldn't have gotten very far without willing investors who stood ready to buy the repackaged subprime debt. There was no shortage of buyers because these instruments offered a tempting higher yield.

So who was bingeing on subprime-backed debt and contributing to the creation of a thriving end market for these instruments? Some of the biggest casualties so far happened at Bear Stearns (BSC, news, msgs), where two hedge funds run by Ralph Cioffi blew up earlier this year, costing investors in those funds an estimated $1.6 billion. Bear Stearns declined to comment.

The biggest subprime-related disaster in the mutual fund world has played out at Regions Morgan Keegan Select High Income (MKHIX), according to Morningstar analyst Scott Berry. The fund, run by Jim Kelsoe, is down nearly 50% this year. Morgan Keegan declined to comment. But in a Nov. 7 note to shareholders, Kelsoe said that 14% of the Select High Income fund portfolio was linked to subprime mortgages. He said many debt instruments in his portfolio no longer trade. So their values are based on models projecting future cash flows, and "there are no optimistic projections at this time."

Continued: Too complex to understand

READ MORE: MORTGAGES - CREDIT CRUNCH - FUNDS - GREENSPAN

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