Wednesday, May 28, 2008

Anatomy of Mortgage Fraud

From the WSJ:

Already burned by bad mortgages on their books, lenders now are feeling rising heat from loans they sold to investors.

Unhappy buyers of subprime mortgages, home-equity loans and other real-estate loans are trying to force banks and mortgage companies to repurchase a growing pile of troubled loans. The pressure is the result of provisions in many loan sales that require lenders to take back loans that default unusually fast or contained mistakes or fraud.

These are standard securitization provisions. What they essentially say is "if the loan I purchase goes bad really quickly, you'll buy it back." The fact that no one has thought to aggressively use these provisions before is interesting. I guess loan purchasers thought that securitization would parse the risk into so many tranches that it would go away. Oops.

Repurchase demands are coming from a wide variety of loan buyers. In a recent conference call with analysts, Fannie Mae said it is reviewing every loan that defaults -- and seeking to force lenders to buy back loans that failed to meet promised quality standards. Freddie Mac also has seen an increase in such claims, a spokeswoman says, adding that most are resolved easily.

When Freddie and Fannie start doing this, everyone will. Freddie and Fannie are responsible for the largest portion of the mortgage market, so they set the "industry standard." Again -- shouldn't they have been doing this before to save the taxpayers money?

Additional pressure is coming from bond insurers such as Ambac Financial Group Inc. and MBIA Inc., which guaranteed investment-grade securities backed by pools of home-equity loans and lines of credit. In January, Armonk, N.Y.-based MBIA began working with forensic experts to scrutinize pools it insured that contained home-equity loans and credit lines to borrowers with good credit. "There are a significant number of loans that should not have been in these pools to begin with," says Mitch Sonkin, MBIA's head of insured portfolio management.

I've been really critical of the rating agencies throughout this scandal. In fact, my disdain has only grown. It's obvious from the above statement that the ratings agencies haven't done anything remotely close to meaningful due diligence on anything they've rated during the last cycle.

And on a related noted, the ratings agencies are now looking for internal sacrificial lambs:

Moody's Corp. employees may be fired if the firm finds that errors in calculating credit ratings for certain products were covered up, people familiar with the matter said, marking a turn away from the firm's more-defensive stance for months.

Moody's had been saying it did nothing wrong in its rating business during the last few years, despite dramatically lowering many of the ratings on the securities it tracked.

The firm's heightening internal investigation, which may conclude by next month, comes as the Securities and Exchange Commission widens its own probe into rating-firm conduct. The SEC is focused chiefly on how Moody's Investors Service, McGraw-Hill Cos.' Standard & Poor's unit and Fimalac SA's Fitch Ratings rated billions of dollars in mortgage-related securities.

Expect a bunch of middle-level managers who were only following orders from senior executives to get fired for this. I also wouldn't be surprised if a few of them left some really incriminating paper trails like emails stating, "what you're asking me to do is wrong."

And here's a surprise -- the biggest problems appear to be coming from .... Countrywide Financial:

Countrywide Financial Corp., the largest mortgage lender in the U.S., said in a securities filing this month that its estimated liability for such claims climbed to $935 million as of March 31 from $365 million a year earlier. Countrywide also took a first-quarter charge of $133 million for claims that already have been paid.

Maybe that's why there's a criminal investigation of Countrywide going on:

The Federal Bureau of Investigation and the criminal division of the Internal Revenue Service have formed a task force to examine mortgages that were made with little or no proof of the earnings or assets of borrowers, a government official who had been briefed on the matter said Sunday.


In March, the Justice Department and the F.B.I. began investigating whether the Countrywide Financial Corporation, the troubled mortgage giant, misrepresented its financial condition and loans in filings with the Securities and Exchange Commission.

Countrywide is also under scrutiny by California and Illinois; federal prosecutors in Sacramento; and the United States Trustee, the federal agency that monitors bankruptcy courts. The S.E.C., meanwhile, is examining stock sales by certain Countrywide executives.

When we look back on this entire event we're going to see a glaring problem: when no one is enforcing the rules they get broken.