| Image by Christopher Myers Most people who have heard of New Century Financial Corp. think of it as a formerly high-flying California-based mortgage lender manned with drunken youngsters who made idiotic loans and reaped millions in fees.But New Century is also a real estate investment trustREIT, for shortand is organized, for the purpose of its charter, in the state of Maryland.That means that the people suingand those investigating, subpoenaing, and otherwise communicating withNew Century through the legal system must send their process server to its resident agentthe Corporation Trust Incorporated, at 300 E. Lombard St., Baltimore.Inside the towering modern office building, on the door of Suite 1400, is a paper sign addressed to process servers: "Please sign in and wait at the counter for someone to help you. We thank you for your cooperation."Mark Diffenbaugh, the Corporation Trust's regional manager, sits at a low cubicle wearing jeans and an open-collar shirt. This office alone serves as a legal address for more than 20,000 corporations, but the company is much bigger than just the Baltimore office. "We service more than 300,000 companies," he says, adding that the Corporation Trust has offices in all 50 states, and has been in business since the 1890s.Diffenbaugh confirms that the California U.S. attorney had to serve his grand jury's New Century subpoenas in Baltimore, 2,600 miles away from New Century's actual place of business. "You can serve process by Federal Express or in person," he says.A REIT is a corporate entity that pays no corporate taxes as long as it pays almost all of its profits to shareholders as dividends. That saves the corporation money, and supposedly simplifies the bookkeeping. Congress invented REITs in 1960, allegedly to give smaller investors a way to invest in big commercial real estate deals.But REITs grew into much more than that.As often happens when Congress writes a law, lawyers found ways to make REITs into a tax dodge. Big corporations structured their own properties into "captive REITs," renting their own stores and office buildings to themselves. With one hand they deducted this "rent" from their taxable income; with the other hand they collected the rent and passed it as a tax-free profit to the REIT shareholdersi.e., the corporation. On March 6 Maryland Comptroller Peter Franchot announced a crackdown on this "loophole."Franchot took pains to say that he doesn't wish to offend REITs generallyjust the tax-dodge variety now so popular among big-box retailers. "We like them," says Franchot spokesman Joseph Shapiro, speaking of legitimate REITs. "It does bring in some income for the state. Anything that helps encourage economic development in the state is good."Maryland is to REITs what Delaware is to ordinary C-corporations: a place to do business on the cheap with no pesky taxes or regulations.According to Franchot, 326 REITs paid the $300 filing fee to Maryland last year, making Maryland home "to well over 50 percent of the nation's REITs, according to the National Association of Real Estate Investment Trusts."New Century is one of themand more than merely paying a $300 filing fee, the company paid a total of $803 for four filings in 2006mostly to sell more stock.The nation's third-largest originator of high-interest "subprime" residential mortgages, New Century was in a business that used to be dominated by banks and savings and loan associations. But in the 1980s, newly deregulated S&L's lent billions for commercial real estate deals that turned out to be bogussometimes the buildings weren't even there. The result became known as the "S&L scandal," and it cost taxpayers about $125 billion.After the S&L scandal, banks got skittish about making mortgages. S&L's disappeared almost entirely. But mortgage brokers started taking requests for home loans and then finding someoneanyoneto lend the money. The lightly regulated business grew by multiples. The National Association of Mortgage Brokers had 14,000 members in 2003. By 2006 it counted 27,000 members. The organization estimates that more than 418,000 people work in the industry.Part of the reason for this explosive growth: One does not need a college degree, or even a high-school diploma, to be a mortgage broker. Although mortgage brokers gain access to sensitive financial information, anyone can be a mortgage brokereven a convicted felon. Maryland does require a criminal background checkas of Jan 1, 2007.Borrowers were happy. Suddenly they no longer needed to run from bank to bank begging futilely for someone to lend them money. And the burdensome demand for documentationtax records, pay stubswas all but abolished as well. New Century and similar outfits didn't need no stinkin' "proof of income."Wall Street was happy, too. Investors wanted to park their money where it would make way more money, and with the end of the tech-stock bubble in 2000, lots of rich people and institutions shifted their cash into mortgage-backed securities.Taking no-doc loans from brokers in all 50 states, New Century supplied a steady stream of mortgages that Wall Street investment banks could bundle into "securities" based on their underlying interest rates. So long as most of the borrowers paid back their loans, the investors made money, and the young, drunken idiots at New Century and similar companies made lots of money in fees for, in the words of one former employee, just showing up.Investors in New Century's stock did well, too, for a time. Shares topped $50 in 2005, while the company paid nice dividends as required by its REIT structure.But as the housing bubble burst last summer, New Century's borrowers began defaulting on their high-interest loans at an alarming rate. And instead of increasing its loan-loss reserves, New Century papered over the problems.Part of the problem appears to have been the REIT structure itself, which required profits to be immediately passed through to the shareholders, rather than salted away for this rainy day.The bad loans got worse, and beginning in early February the company started unraveling amid an investigation by the Securities and Exchange Commission. On Monday, March 12, the company announced that its lenders had all stopped giving it money. The New York Stock Exchange delisted the stock. Shares are worth roughly 85 cents today.New Century is not the only home mortgage lender to become a Maryland REIT and get in trouble--Novastar Financial is also headquartered at 300 E. Lombard St., Suite 1400--but New Century is the biggest so far.The consequences for Maryland?Presumably, the state will no longer be able to collect those hefty $200 and $300 filing fees, so there's a big loss to "economic development" right there.But will Maryland move to regulate REITs to prevent future disasters like this? We called the State Department of Assessments and Taxation repeatedly to try to get an answer, but the man said to be in charge of the state's REIT desk was reportedly in Annapolis and did not return our phone calls.
Edward Ericson Jr.
- Investment Service
- U.S. Securities and Exchange Commission