TAHER AFGHANI was working for discount retailer Target Corp. near San Francisco when friends told him about the riches to be made in California’s Mortgage Alley.

It was 2004, and the US real-estate market was on fire. Down in Southern California, a hub for lenders specializing in loans to people with weak, or subprime, credit, Afghani’s pals were making a fortune pushing risky mortgages on homebuyers.

After tagging along with a buddy on a company trip to Los Cabos, Mexico, Afghani quit Target, headed south and began hustling loans at Costa Mesa-based Secured Funding Corp.

“I had never seen so much money thrown around in one weekend,” Afghani, 27, says of the Cabo getaway. “It was crazy. All these kids, literally 18 to 26, were loaded—the best clothes, the cars, the girls, everything.”

Soon Afghani, who’d made $58,000 a year managing a Target distribution center, was pulling down $120,000.

Mortgage salesmen like Afghani, many of them based in Orange County, near Los Angeles, lie at the heart of the once profitable partnership between subprime lenders and Wall Street investment banks that’s now unraveling into billions of dollars in losses. After years of easy profits, a chain reaction of delinquency, default and foreclosure has ripped through the subprime mortgage industry, which originated $722 billion of loans last year. Since the beginning of 2006, more than 50 US mortgage companies have put themselves up for sale, closed or declared bankruptcy, according to data compiled by Bloomberg.

Lenders such as Irvine, California-based New Century Financial Corp.; Orange, California-based ACC Capital Holdings Inc.; GMAC LLC’s Residential Capital home lending unit; and General Electric Co.’s WMC Mortgage Corp. division have slashed more than 5,000 jobs.

The upheaval in Orange County, home of Disneyland and birthplace of Richard Nixon, has sent shockwaves throughout the financial world. Brokers are merely the first link in a chain stretching from mortgage companies, which originate loans; to wholesale lenders, which bundle them together; to Wall Street banks, which package the bundles into securities; and finally to commercial banks, hedge funds and pension funds, which buy these investments.

The pain has only just begun. As home prices sink and mortgage defaults climb, bond investors who financed the US housing boom stand to lose as much as $75 billion on securities backed by subprime mortgages, according to Newport Beach, California-based Pacific Investment Management Co., which runs the world’s largest bond fund. Companies from Detroit-based General Motors Corp. to Zurich-based UBS

AG have fallen into the subprime sinkhole.

At GM, profit plunged 90 percent during the first three months of 2007 because of mortgage losses at its 49 percent-owned GMAC finance company. Swiss banking giant UBS said in May that it would shut its Dillon Read Capital Management arm after the hedge fund manager lost 150 million Swiss francs ($123 million) in the first quarter, partly on subprime investments.

Subprime originations fell 10.3 percent to $722 billion in 2006 from a record $805 billion in 2005, according to JPMorgan Chase & Co. Credit Suisse predicts a 40-percent to 60-percent slide this year.

THE party is over in Orange County. These days, Secured Funding’s once-buzzing office building in Costa Mesa, near John Wayne Airport, is gutted. The imprint of ‘’Secured Funding’’ is all that remains of the corporate logo that once graced the outside of the two-story building.

Above it is a ‘’For Lease’’ sign advertising the 7,649-square-meter building.

“They cut way back,” a construction worker says, shrugging. What little remains of Secured Funding is now housed in a building across the near-empty parking lot, where a receptionist tells a caller: “Our wholesale division is closed. We’re no longer doing business with brokers.”

The subprime industry—and investors’ losses—would never have gotten so big were it not for a small army of independent mortgage brokers and hustling salesmen like Afghani, who was fired in October.

He and other subprime veterans say their job was to reel in borrowers, period. Never mind whether customers needed loans or could manage payments. Afghani says sales pitches typically focused on what a borrower could do with all of that money rather than on fees buried in paperwork or annual interest rates as high as 10.5 percent at the time, at least 2 percentage points more than the rates that banks charge people with good credit.

“Even with explanations, most borrowers didn’t really understand what types of loans they were getting,” says Maureen Mc-Cormack, another former Secured Funding employee. “They just cared about the monthly payment.”

The sales job was made easier with exotic mortgages such as so-called no-doc loans, which enable borrowers to get loans without having to supply evidence of income or savings, and option ARMs, adjustable-rate mortgages that let people pick how big a payment they will make from month to month.

The loans offer upfront teaser rates at the cost of tacking the deferred payments onto the balance of the loan.

“Heavy sales pressure has been part of the most-egregious lenders for a while,” says Kurt Eggert, a professor at Chapman University School of Law in Orange, California, who has studied the role of aggressive sales tactics in subprime lending and sued lenders on behalf of elderly borrowers caught up in home equity scams.

However brokers snared customers, lenders in California typically sold the loans to big banks or Wall Street firms. Under US law, investors who buy mortgages or securities backed by them are typically not susceptible to lawsuits alleging fraud on the part of brokers.

Such protection partly explains why the US mortgage-backed-securities (MBS) market has ballooned. The market more than tripled since 2000; $2.4 trillion of MBSs were issued last year, according to the Securities Industry and Financial Markets Association in New York. Last year was the first time more than half of the securities issued were backed by subprime and other nonconforming loans, according to the trade group. “The market is driven by volume and passing along the risks associated with it,” says Paul Leonard, director of the California office of the Center for Responsible Lending, a Durham, North Carolina-based consumer advocacy group. “With the appetite of the secondary market, neither brokers nor originators had much accountability.”

Lenders push sales of subprime loans as far down the chain as possible to vast networks of brokers. While independent brokers account for about half of all mortgage originations, they handle as much as 70 percent of subprime originations, according to the Mortgage Bankers Association of America. Many of the biggest subprime casualties, including Santa Monica, California-based Fremont General Corp.; Kansas City, Missouri-based NovaStar Financial Inc.; and New Century Financial, would never have grown as fast as they did without their ability to outsource the bulk of their sales to outside brokers and salesmen. New Century, before tumbling into bankruptcy on April 2, used a network of 47,000 mortgage brokers and 222 branch offices to grow to $59.8 billion in annual loans last year from just $400 million in its first year, in 1996, according to company filings.

Even before the bottom fell out of the subprime market, NovaStar and other lenders were defending themselves against lawsuits that accused the companies of using independent brokers and branch salesmen to exploit borrowers with high-cost loans. A lawsuit filed against Nova-Star in federal court in Memphis, Tennessee, in April 2006, for example, centers on allegations that NovaStar used mortgage brokers to prey on minority borrowers, in this case a 61-year-old black woman who claims to have heard pitches for “easy money” on a local gospel radio station.

Among other allegations, the plaintiff, Mae Jackson of Memphis, claims she was never informed about the terms of the loan, including the amount, the interest rate or the closing costs. In her complaint, she attacks NovaStar’s practice of using mortgage brokers who employ “deceptive high-pressure tactics to foist these unfair and discriminatory subprime loans onto unsuspecting minority borrowers.”

In court filings, NovaStar pins the blame on the mortgage broker, Memphis-based Worldwide Mortgage Corp., which filed for bankruptcy in April 2006. In a separate statement, NovaStar says that contrary to the plaintiff’s portrayal of herself as naive, Jackson was a “real-estate investor who owned five properties at the same time.” Neither she nor her attorneys have provided any evidence of discrimination, NovaStar says. Jackson couldn’t be reached for comment.

Like many subprime lenders, NovaStar spread its tentacles by tapping into a broad base of mortgage brokers and so-called net branches. A net branch enables an independent broker to set up shop under Nova-Star’s or some other company’s banner with little upfront investment, much less a state license, and quickly begin brokering loans to kick upstream to the parent.

NovaStar made great use of the technique: By the end of 2004, it had expanded its number of branches to 432 from four at the beginning of 2000. At their peak in 2003, NovaStar’s branches brought in $1.2 billion of loans, a fifth of the total $6 billion in subprime loans originated by the company that year. “The branches represent a competitive advantage for NovaStar as we seek greater market share,” the company said in its 2003 annual report.

Several lawsuits filed against Nova-Star paint a more sinister picture. They claim the company played fast and loose with state licensing requirements in an effort to make results look better than they might have without the aid of the branch loan sales. “NovaStar had woefully failed to comply with federal and state regulations as a result of defendants’ efforts to expand the company’s business at all costs,” alleges one 94-page complaint filed in November 2004 in federal court in Kansas City and certified as a class action this past February.

The firm is facing at least seven class actions, according to Bloomberg data. Among other allegations, the Kansas City lawsuit claims NovaStar fraudulently puffed up borrowers’ assets to qualify customers for loans. One unnamed former employee, identified as a “loan officer” who worked in California from 2002 to 2003, told plaintiffs’ lawyers that employees would apply an “XActo knife and some tape” to borrowers’ W-2 forms and paychecks to qualify them for loans. The same employee said that on other occasions, the company would temporarily deposit $5,000 in the bank account of a potential borrower to inflate his or her assets.

NovaStar would either take the money back or increase the loan fees, according to the lawsuit filed by co-counsel Milberg Weiss & Bershad LLP of New York. “NovaStar believes it is irresponsible to continue to print

the false and inflammatory allegations regarding lending activities contained in this lawsuit, given that the plaintiffs have never produced any evidence to support them and they are not actually a part of the underlying claim,” NovaStar spokesman Richard Johnson said in a statement.

Johnson says three state and federal licensing and compliance actions involving the branches filed against NovaStar that are detailed in the lawsuit amount to much ado about nothing. “None of NovaStar’s operations in these states, or nationwide, were materially affected or in danger of being materially affected, in any way, and therefore those actions did not require disclosure at the time,” Johnson said in his statement. The company announced in April it was exploring “a range of strategic alternatives,” including a sale.

MANY subprime sales techniques are now spilling out in the lawsuits, advocacy reports and Congressional hearings that predictably follow such industry meltdowns. Several lawsuits illustrate the lengths to which the big wholesalers, and ultimately Wall Street, were able to outsource the selling of the loans as far down the chain as possible. Fremont General’s Fremont Investment & Loan, Wells Fargo & Co.’s home mortgage unit and a rogue’s gallery of mortgage brokers come under such scrutiny in a lawsuit filed in August 2006 in San Mateo County, California, state court.

Plaintiff Johnnie Damon claims he was “fraudulently induced” to take out a $484,000 loan from Irvine-based mortgage broker Peak Funding Inc., which allegedly falsified Damon’s financial records to qualify him for the loan. Damon claims he asked for a reverse mortgage, which enables homeowners to borrow money in the form of payments charged against their home equity, and instead got a “traditional refinance loan” without his knowledge.

Also without Damon’s knowledge, the claim says, the mortgage broker falsified information on his loan application, such as his monthly income, to qualify him for the loan. Fremont sold servicing rights on the loan, which is the right to process monthly payments, to San Francisco-based Wells Fargo and flipped the loan itself to Paris-based Société Générale SA.

Wells Fargo is also named as a defendant for ignoring “fraudulent and predatory lending practices” in the loans it purchases and services, according to the lawsuit.

The complaint also alleges that Fremont, prior to its recent decision to exit the subprime business, was using mortgage brokers to do its dirty work. “Fremont has a history of intentionally turning a blind eye to fraudulent and predatory lending practices by the mortgage brokers who generate home loans for the company,” the lawsuit alleges without citing any other specific examples. Expanding on the accusations, Damon’s attorney, Aaron Myers of Howrey LLP, says Fremont funded a loan made “by a bunch of crooks who completely misled the borrower, falsified his income, coerced him into the loan and then tricked him into sending the loan proceeds back to the company.”

In answers to the complaint, all of the defendants deny the accusations. “Wells Fargo’s trivial role in this case is punctuated by the fact that it has not caused the plaintiff any harm,” Wells Fargo’s attorneys said in an October 10, 2006, court filing, adding that they put a hold on the loan after the dispute erupted. “Wells Fargo does not belong in this case.”

Robert Cannone, a former chief financial officer and director of Peak Funding who’s also listed as a defendant by name, says the firm closed last October after it ran out of money. He neither admits nor denies wrongdoing.

“I’m so embarrassed,” Cannone says in a telephone interview. “I feel really bad.”

He says that of the 100 loans made by Peak, this is the only one in dispute. He says an employee connected with the Damon loan “went off the reservation.”

When the boom went bust, even people on the periphery of the industry got caught in the downdraft. Carrie Feinman worked in Scottsdale, Arizona, in the wholesale prime lending division of New Century Financial, which acquired nonsubprime loans from smaller lenders and mortgage brokers. The relative health of her side of the business, which New Century acquired from Royal Bank of Canada in 2005, couldn’t stop New Century’s troubled subprime lending from dragging the entire company into Chapter 11 on April 2.

Feinman says the news that the company was filing for bankruptcy came out of the blue, leaving her and most other employees out of pocket on unused vacation time and severance pay. “We were shocked,” says

Feinman, who’s looking for a job. “If I had quit the week before, I would have gotten my vacation time. You wonder why no one is loyal to employers anymore.”

A MONTH after leaving Secured Funding, Afghani took a new job at Irvine-based Solstice Capital Group Inc., another subprime lender. HSBC, the same bank that had been buying loans from Secured Funding, bought Solstice last year for $50 million.

Afghani quit in April, vowing to find a new line of work. “Enough is enough,” he says, adding the good times are long gone.

“I’m so rock bottom I had to move out of my apartment in Irvine and live rent free with my girlfriend,” he says.

The hard knocks have taught him a lesson, Afghani says. “It was tough love and agreat learning experience to live within your means and not end up like the individuals on the other side of the phone,” he says.

The subprime sinkhole

TAHER AFGHANI was working for discount retailer Target Corp. near San Francisco when friends told him about the riches to be made in California’s Mortgage Alley.

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