SACRAMENTO — On Wall Street it was spring 2005 "when we began to hear the first jokes about the housing market," writes Lawrence McDonald, vice president at Lehman Brothers before its historic September 2008 collapse.
McDonald, author of a riveting new inside history of Lehman, "Colossal Failure of Common Sense," says, "One name in particular kept popping up on the joke menu: Stockton."
Wall Street traders jokingly called the port city a "subprime nirvana" that helped pioneer the NINJA mortgage: "No income, no job, no assets."
But it was more than Stockton that rang the first alarm bells at the massive New York investment bank. It was California's entire Central Valley: thousands of people with small salaries who had gorged themselves on cheap teaser loans and big, two-story, new houses.
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That attitude from Wall Street toward the valley is not surprising, but it is disturbing, said Mike Zagaris, president of PMZ Real Estate in Modesto.
"It is extremely disappointing that people in Lehman Brothers would make jokes about Stockton," he said Thursday. "It suggests that they were both insensitive and exploitative in their relationship to the people in Stockton and the Central Valley."
The book's author worked in Lehman's distressed debt division, where traders made large sums guessing which company and industry was headed for the skids, then shorting their stocks.
"The housing boom was so widespread it was difficult to know where to start," he wrote. "But we kept coming back to California, and that invariably led to the central part of the state, especially along Route 99, the original two-lane highway that starts just south of Bakersfield and runs to Sacramento."
Refugees were pouring in from expensive coastal zones "into rows and rows of brand new houses. They were digging up the asparagus fields to build more."
Craig Lewis, president of Prudential California Realty in Modesto, said the housing gold rush to the Central Valley was a reflection on the area's housing supply and demand.
"There's not a lot of places in the Bay Area to build homes; consequently, we had a tremendous commuter market here," he said. "If you are in California and want to have inexpensive homes and more supply, where is that going to be but the Central Valley?"
Through 2005 and 2006, even into early 2007, McDonald wrote in the book, doubts were not officially entertained at Lehman meetings, especially "when the mortgage guys swaggered in with their balance-sheet-busting results for the month. Because they had the perfect retort: 'We're making this much money because we know precisely what we're doing, and because the U.S. housing market always goes up.' That's always, not sometimes, not usually."
It's that mentality, said University of the Pacific professor John Knight, who teaches finance and real estate, that led to the influx of speculators in the Central Valley market who were buying homes not to live in or rent, but to flip and sell for more.
In Stockton alone, 25 percent of the houses were sold to investors seeking to make quick profits.
"I can't imagine that so many smart people just completely missed the fact that the fundamentals were out of whack," Knight said. "I think that some or not all of them knew that the music was going to stop at some point. But it was too much fun. Who wants to be the one to take away the punch bowl?"
But then, the market crashed.
McDonald writes that people began spilling out of the houses they couldn't afford in Bakersfield, Modesto and Sacramento.
"This was nothing like a few guys in over their heads; now there was a whole scattered army on the march, getting out of their new homes and going back to the poorest areas of the cities where they could afford to live," he said.
Big subprime lenders collapsed and then, "fear, that most terrible of Wall Street predators, was suddenly lurking in our conference room," he wrote.
Recalling early 2005 when the doubts began, McDonald wrote, "There was not one shred of evidence that the mortgage bonanza would ever go wrong or that house prices would fall. But by golly, if they ever did, Stockton would surely be ground zero for financial crisis."
Five years have passed. Stockton, Merced, Modesto and the rest of the Central Valley are a wreck.
McDonald's story of Lehman Brothers tells how a band of skeptics once watched this Central Valley landscape from afar, joked about it, saw this coming.
Modesto Bee staff writer Marijke Rowland contributed to this report.