March 30, 2013

MBS workers were personly long housing in 2006: did not expect problems in the wider housing market. Certain groups of securitization agents particularly aggressive in exposure to housing

New research suggests that financial workers involved in the mortgage-securitization business -- ground zero for the misaligned incentives that are supposed to have helped inflate the bubble -- were true believers in the housing boom.

In 2006, there were 1,760 registered attendees at the American Securitization Forum's conference in Las Vegas -- the major annual confab for the securitization industry. Screening out people who didn't work in mortgages, and making sure to oversample firms that worked at large financial institutions, as well as institutions that played a prominent role in the financial crisis, like Lehman Brothers, economists Wei Xiong at Princeton and Sahil Raina and Ing-Haw Cheng at the University of Michigan's Ross School of Business came up with a list of 400 mortgage-securitization professionals.

These were basically midlevel managers -- the people directly involved in the slicing and dicing of mortgage loans into the myriad of mortgage securities that institutional investors were lapping up during the boom years.

Using the LexisNexis database of legal documents, the economists collected data on all the properties the people on their list ever owned, including location, time of sale and price. They then created two control groups to repeat the exercise with. The first was a list of equity analysts who worked for a similar set of finance firms as the securitization workers, and who didn't cover housing companies. The second was a list of lawyers who didn't work in real estate law -- a wealthy group that reflects how people outside of finance behaved during the bubble.

The economists found that the securitization workers showed no awareness that housing was about to become undone. To the contrary, during the peak of the bubble, they were far more apt to swap into more expensive homes and buy second homes than the control groups were. And workers at firms like Bear Stearns and Lehman Brothers were among the most aggressive with their own home purchases.

To the argument that the aggressive home purchases of securitization agents might have reflected the higher bonuses they received during the boom years relative to, say, the equity analysts in the control group, Mr. Xiong points out that if were true, if they had any sense that their future income was at risk they would have plowed their money into something other than houses. Indeed, after the housing bust came, the securitization agents were far more likely to put their houses back on the market than the control groups, which suggests they were getting forced into sales.

The upshot, says Mr. Xiong: "These guys might have had bad incentives, but there's no sense they knew about the bubble."

October 18, 2012

Mortgages gone bad -- blockback to underwriters, issuers ?

MBS issuers often assert their own put-back claims against mortgage originators, for instance. But JPMorgan still has an enormous put-back claim by a group of major institutional investors in almost $100 billion of mortgage-backed notes hanging over its head. And lately, the MBS headlines have all been about repurchase claims against JPMorgan. I've said it before: Bank of America's MBS woes are so 2011. These days, at least when it comes to private-label litigation, it's all about JPMorgan.

I told you last week about the hedge fund Baupost's put-back case against JPMorgan's EMC unit in Delaware Chancery Court -- one of the very few cases in which a private investor (as opposed to a bond insurer or government-sponsored entity) has successfully forced an MBS trustee to assert claims on its behalf. But the bond insurers have been busy as well. MBIA filed a new suit against JPMorgan last Friday in federal court in White Plains, New York, claim in g that its predecessor Bear Stearns fraudulently induced MBIA to insure a GMAC securitization. (Okay, it's not a put-back suit, but the claims, as described by MBIA's lawyers at Quinn Emanuel Urquhart & Sullivan, are similar.)

Meanwhile, the bond insurer Ambac and its indefatigable counsel from Patterson Belknap Webb & Tyler are rocketing along in Ambac's sweeping fraud and put-back case against Bear Stearns and its onetime mortgage arm, EMC Mortgage. As the financial writer Teri Buhl was the first to report at her website, last month Ambac brought an action in Connecticut state court seeking to compel the loan reviewer Clayton Financial to produce the Bear MBS documents Ambac has subpoenaed. Clayton was one of the companies (along with Watterson Prime) frequently hired by MBS issuers to re-underwrite loans they purchased from mortgage originators to assess the mortgages' quality before they were securitized. Clayton has been thoroughly scrutinized in the mortgage mess, by former New York attorney general Andrew Cuomo and the Senate's permanent subcommittee on investigations, among others. So it's not news that the company has loan-level information that could support bond insurer claims that Bear bundled deficient mortgages into MBS trusts. But the Patterson Belknap filing included excerpts of deposition testimony from a whistle-blower who worked at both Clayton and Watterson. Like the recently filed, amended Baupost complaint, the whistle-blower deposition excerpts are another example of actual evidence that the due diligence and underwriting shenanigans you see described in complaints against MBS defendants really happened.

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December 31, 2011

Risk ratings, structured finance who's who

The departures of Ms. Tillman and Ms. Rose come as S&P President Doug Peterson works to forge a new identity for the firm and restore a reputation tarnished by the crisis. The former Citigroup Inc. banker has sought to enhance the firm's internal controls while championing analysts' independence.

Some former S&P analysts say those changes, some under way since Mr. Peterson took over in September, have been slow going. They say many of their one-time colleagues who oversaw the ratings on complex mortgage-linked deals have remained at the firm since 2008--despite calls from investors, regulators and lawmakers for wholesale changes to the way S&P and the other major rating firms do business.

An S&P spokesman declined to comment.

Despite the backlash, S&P and rivals Moody's Investors Service and Fitch Ratings remain the dominant players in the business of ratings everything for corporate and sovereign debt to asset-backed securities.

The Justice Department and the Securities and Exchange Commission are investigating S&P's crisis-era ratings on mortgage-linked deals, people familiar with the matter have said. Former S&P employees who have been questioned as part of the probe say that Justice Department investigators have expressed consternation that so many of the managers who oversaw the ratings on mortgage-linked securities remain at the firm, making it difficult for them to speak with a broad group of former analysts.

A Justice Department spokeswoman declined to comment.

Mr. Peterson succeeded Deven Sharma in September. S&P replaced its chief credit officer, Mark Adelson, in early December. Mr. Adelson was hired by Mr. Sharma in May 2008 and given the mandate to make it harder for debt-issuers to earn a triple-A from the firm. Mr. Adelson was moved to a "senior research fellow" position, considered by former and current S&P employees to be a demotion. At the time Mr. Adelson had declined to comment.

The firm also announced earlier this month that David Jacob, who succeeded Ms. Rose as S&P's structured finance chief, would step down at the end of the year.

Continue reading "Risk ratings, structured finance who's who" »

April 5, 2011

Covered Bonds and Qualifying Mortgages

Covered bonds are pools of debt obligations that have been assembled by banks and sold to investors who receive the income generated by the assets. The bank that issues the bonds, meanwhile, retains the credit risk. If losses arise, the bank that issued the covered bonds must offset the loss with its own capital. That could push troubled banks closer to the edge.

If an asset in the pool defaults, a separate entity would be required to remove the assets from the bank's control. The assets would then be out of reach of the F.D.I.C. should the bank fail and the agency step in as receiver. The investors who bought the covered bonds would have first call on the assets, ahead of the F.D.I.C.

This structure would wind up bestowing a new form of government backing to the major banks issuing the bonds, raising the potential for losses at the F.D.I.C. insurance fund, which protects savers' deposits.

Equally troubling, the covered bond structure favored by the banks would let the pools invest in risky assets such as home equity lines of credit. These loans have been among the worst-performing assets out there. Covered bonds issued overseas, by contrast, typically consist solely of high-quality loans.

"The industry is trying to do an end run around the F.D.I.C.," said Christopher Whalen, publisher of the Institutional Risk Analyst. "This proposal is about restarting the Wall Street assembly line for selling toxic waste to investors."

Continue reading "Covered Bonds and Qualifying Mortgages" »

March 26, 2011

A.K. Barnett-Hart CDO Thesis

By Peter Lattman

Deal Journal has yet to read "The Big Short," Michael Lewis's yarn on the financial crisis that hit stores today. We did, however, read his acknowledgments, where Lewis praises "A.K. Barnett-Hart, a Harvard undergraduate who had just written a thesis about the market for subprime mortgage-backed CDOs that remains more interesting than any single piece of Wall Street research on the subject."


A.K. Barnett-Hart
While unsure if we can stomach yet another book on the crisis, a killer thesis on the topic? Now that piqued our curiosity. We tracked down Barnett-Hart, a 24-year-old financial analyst at a large New York investment bank. She met us for coffee last week to discuss her thesis, "The Story of the CDO Market Meltdown: An Empirical Analysis." Handed in a year ago this week at the depths of the market collapse, the paper was awarded summa cum laude and won virtually every thesis honor, including the Harvard Hoopes Prize for outstanding scholarly work.

Last October, Barnett-Hart, already pulling all-nighters at the bank (we agreed to not name her employer), received a call from Lewis, who had heard about her thesis from a Harvard doctoral student. Lewis was blown away.

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March 6, 2011

Georgia's anti-predatory-lending law: issuers and investors in mortgage pools held liable for abusive loans.

Back in 2003, for example, Georgia's legislature enacted one of the toughest predatory-lending laws in the nation. Part of the law allowed issuers of and investors in mortgage pools to be held liable if the loans were found to be abusive. Shortly after that law went into effect, the ratings agencies refused to rate mortgage securities containing Georgia loans because of this potential liability. The law was soon rewritten to eliminate the liability, allowing predatory lending to flourish.

Continue reading "Georgia's anti-predatory-lending law: issuers and investors in mortgage pools held liable for abusive loans. " »

December 28, 2010

Credit risk lurking inside Fannie and Freddie

In addition to shielding taxpayers from having to backstop an ever-expanding financial safety net for errant bankers, we also need protection from ballooning losses at Fannie and Freddie. This will require the F.H.F.A. to take other crucial steps.

Janet Tavakoli, president of Tavakoli Structured Finance, a consulting firm in Chicago, has provided a to-do list for officials at F.H.F.A.

In a presentation to the agency's supervision summit meeting last Wednesday in Washington, Ms. Tavakoli said that if the agency hoped to determine the credit risk lurking inside Fannie and Freddie, it needed to ascertain two things: the probability of default on those loans and the loss rates when probable defaults actually occur.

"They have to do their own statistical sampling of their portfolios to get a realistic idea of what those numbers are," Ms. Tavakoli said in an interview. "And it has to be rigorous because we don't know what kinds of impairments to expect from risky new mortgage products combined with a damaged economy and housing market."

The F.H.F.A. cannot rely on estimates from the credit ratings agencies about the extent of those losses, Ms. Tavakoli said. "The whole idea of relying on third parties has not worked," she said. "Once you feel better about the quality of your information, you'll feel more confident about making your next decision."

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August 4, 2010

participation, not assignment

Nevertheless, JPMorgan agreed to sell the loan to Inbursa on July 15, 2009, court documents show. It did not inform Cablevision and went ahead with the deal despite the fact that Grupo Televisa and other banks were interested in purchasing part of the loan.

When it sold the loan to Inbursa, JPMorgan structured it as a participation agreement rather than an assignment; such agreements can be sold without the borrower's consent. Still, the terms of the original Cablevision loan stated that participations could be sold only if the lending relationship between JPMorgan and Cablevision did not change significantly. Cablevision argued that the transaction with Inbursa did just that.

Cablevision learned that the sale to Inbursa required JPMorgan to hand over virtually any information Inbursa wanted about Cablevision. Court documents show that this language was added to the agreement at Inbursa's request.

Continue reading "participation, not assignment" »

May 3, 2010

Of AAA-rated subprime-mortgage-backed securities issued in 2006, 93 percent have now been downgraded

the e-mail messages you should be focusing on are the ones from employees at the credit rating agencies, which bestowed AAA ratings on hundreds of billions of dollars' worth of dubious assets, nearly all of which have since turned out to be toxic waste. And no, that's not hyperbole: of AAA-rated subprime-mortgage-backed securities issued in 2006, 93 percent -- 93 percent! -- have now been downgraded to junk status.

Krugman illustrates the integrity of NRSRO (Nationally Recognized Statistical Rating Organization) which look at new evidence, and in light of new evidence are willing to revise their ratings. And Krugman notes the difficulty in monetizing intellectual property in the Internet age:

What we really need is a fundamental change in the raters' incentives. We can't go back to the days when rating agencies made their money by selling big books of statistics; information flows too freely in the Internet age, so nobody would buy the books. Yet something must be done to end the fundamentally corrupt nature of the the issuer-pays system.

Continue reading "Of AAA-rated subprime-mortgage-backed securities issued in 2006, 93 percent have now been downgraded" »

April 25, 2010

Goldman CDOs collapsed, but were made of rated mortgages ?

The woeful performance of some C.D.O.'s issued by Goldman made them ideal for betting against. As of September 2007, for example, just five months after Goldman had sold a new Abacus C.D.O., the ratings on 84 percent of the mortgages underlying it had been downgraded, indicating growing concerns about borrowers' ability to repay the loans, according to research from UBS, the big Swiss bank. Of more than 500 C.D.O.'s analyzed by UBS, only two were worse than the Abacus deal.

Banks Bundled Bad Debt, Bet Against It and Won
Published: December 24, 2009
Investigators are trying to determine whether banks like Goldman Sachs intentionally sold their clients especially risky mortgage-linked assets.

Posted to Structured Finance.

Continue reading "Goldman CDOs collapsed, but were made of rated mortgages ?" »

February 2, 2010

It's not insurance if you're the only customer

Insurance regulators said Delaware did not consider credit-default swaps to be insurance.

"I don't think an insurance commissioner should tread on the toes of the banking industry," said Karen Weldin Stewart, the commissioner in Delaware. "This started out as a bank product."

Her special deputy for examinations, John Tinsley, explained the reasoning. "In insurance, you're putting together a pool," he said. Each customer would be charged a premium based on the total risk of the pool.

A credit-default swap cannot be insurance, Mr. Tinsley said, because it does not involve a pool. There is just one seller and one buyer for every contract.

"It's an investment product," he said. "It's closer to buying an option."

Not everyone agrees. Eric R. Dinallo, New York State's insurance superintendent when A.I.G. imploded, said he believed credit-default swaps were insurance and should be regulated as such.

Continue reading "It's not insurance if you're the only customer" »

August 17, 2009

Credit derivatives market will strip out and repackage credit exposures from the vastly greater pool of risks which do not naturally lend themselves to securitisation, Lady Blythe Masters

The Party Starter, Blythe Masters:

"Just as the rapidly growing asset backed securitisation market is bringing investors new sources of credit assets, the credit derivatives market will strip out and repackage credit exposures from the vastly greater pool of risks which do not naturally lend themselves to securitisation, either because the risks are unfunded (off-balance-sheet), because they are not intrinsically transferable, or because their sale would be complicated by relationship concerns."

The best line of course is "By enhancing liquidity, credit derivatives achieve the financial equivalent of a "free lunch" whereby both buyers and sellers of risk benefit from the associated efficiency gains."

from concluding paragraph from her magnum opus - all in the Queen's English of course.

Continue reading "Credit derivatives market will strip out and repackage credit exposures from the vastly greater pool of risks which do not naturally lend themselves to securitisation, Lady Blythe Masters" »

July 10, 2009

Street Fighters (Kate Kelly)

Street Fighters tells an engaging tale focused upon how a mighty firm was reduced to rubble in three days. You know the ending before you start reading, but it is no less engaging. The author has a nice sense of the characters and has done extensive research into backgrounds. We not only learn about the major players, we learn what everyone else thought about them.

Street Fighters aims to tell the story in 72 hours, not examine structural problems in finance, and succeeds.

Continue reading "Street Fighters (Kate Kelly)" »

April 26, 2009

Loan modifications are complicated for invetsors

The danger, some investors and securitization lawyers say, is that these provisions might allow some financial companies that engaged in improper lending -- and also happen to be loan servicers -- to escape legal punishment.

For example, if the servicer of an abusive loan was also the initial lender, the bill would take that company off the hook for any future predatory lending suits. The safe harbor, therefore, could encourage servicers to modify their most poisonous loans, even if they are not yet near default, just to reduce their legal exposures.

And allowing servicers to void buyback requirements on loans they modify would eliminate any liability for breaches in representations and warranties on the loans they made to investors who subsequently bought into the pools.

"Main Street investors need to know that banks who received their tax money through government bailouts are going to profit again from the safe-harbor loan modification provisions at the expense of their mutual funds, 401(k)'s and pension investments," said Thomas C. Priore, chief executive of ICP Capital, an investment firm that specializes in credit markets.

Another perverse incentive that the bill would create involves the problem of conflicting interests among investors who own the first mortgage on a property and holders of the second liens. First liens of any kind take priority and are supposed to be paid off before secondary obligations are. But many of the companies servicing loans today own second liens on the same properties whose first mortgages are held by investors in securitizations.

By removing any liability associated with modifying the first mortgage, the banks that own the second liens can expose invest

Continue reading "Loan modifications are complicated for invetsors" »

January 3, 2009

Market discipline has come to subprime

Primary Market - Loan Originations

Fannie Mae and Freddie Mac do not originate mortgages. More than 80% of subprime loans still outstanding were originated in 2004 through 2007. The top ten subprime loan originators in 2006 were: HSBC Finance, New Century Financial, Countrywide Financial, Citimortgage, WMC Mortgage, Fremont Investment and Loan, Ameriquest, Option One, Wells Fargo Home Mortgage and First Franklin Financial. Seven of the ten (the nonbank lenders, who were not regulated by the Community Reinvestment Act) no longer exist, or were merged into banks. The lists for 2005 and 2004 were similar, but also included Washington Mutual. The top ten lenders accounted for about 60% of ALL subprime loans in 2006.

Secondary Market - Wholesale Loan Buyers

In 2004, 2005 and 2006, securitized mortgages were 73%, 79% and 81% of all subprime mortgages. So for practical purposes the wholesale market was the securitization market. For the same three years, the total volume of subprime loans securitized was $521 billion, $797 billion and $814 billion respectively.

Almost none of those securities were issued by Fannie and Freddie. They were not in the business of purchasing and securitizing subprime mortgages, although they purchased some subprime mortgages to hold in portfolio, and issued about $6 billion in subprime securities in 2004 to 2006 (one-third of one percent of the market.) The top fifteen issuers of subprime mortgage-backed securities, accounting for about 75% of the market, in 2006 were: Countrywide, New Century, Option One, Fremont, Washington Mutual, First Franklin, Residential Funding (GMAC affiliate), Lehman Brothers, WMC, Ameriquest, Morgan Stanley, Bear Sterns, Wells Fargo Securities, Credit Suisse and Goldman Sachs.

Continue reading "Market discipline has come to subprime" »

December 28, 2008

Irony of diversification

Imagine you are stranded on a desert island. For fresh water, there are three natural springs, but it is possible one or more have been poisoned. To minimize your risk, what is your optimal strategy for drinking from the springs? You might:

  • select one of the three springs at random and drink exclusively from it
  • select two of the springs at random and drink exclusively from them, or
  • drink from all three springs.

Your best strategy is to drink from just one spring. Yet, according to a certain financial theory, the optimal strategy is the diversified approach of drinking from all three springs.

Continue reading "Irony of diversification" »

November 26, 2008

D-man on derivatives

Cash is the ultimate financial derivative, according to Emanuel Derman.

One airy invention is the PIK (payment-in-kind) bond, a loan that pays its promised interest in additional bonds of the same kind, as opposed to solid cash. It sounds insubstantial, a barely disguised pyramid scheme in which you make your promised payments each time with further promises of payment, each at least as chancy as a subprime CDO. But think about the dollar: deposit it in the bank for a year and you get more dollars at the end. What is paper money but a PIK, an early derivatives contract? To trust it you have to trust the country that provide its value, and the same is true of payment in kind. Used wisely, maybe payment in kind can serve as hallmark of trust in the financial supply chain too.

September 30, 2008

Price discovery and bad debt

A key holdup to getting past this crisis is the continuing unknown of the remaining value of mortgage-based securities. In Morgan's day, price discovery resulted when he went around the room seeking details of balance sheets. Today we need to achieve price discovery more actively, such as by holding auctions of the bad debt so that the market can find a new normal. Getting our arms around the scope of the bad debt would define the capital needs for banks, and there would be prices set that potential private-sector buyers of the debt could consider.

There have been few efforts to determine the true value of the mortgage-related securities. One was the 22 cents on the dollar that Merrill Lynch got in July by selling some $30 billion in supposed value of mortgage-backed derivatives for just under $7 billion. The average portfolio might be worth closer to 60 cents on the dollar, but whatever the level, once prices settle, financial recovery can begin.


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September 24, 2007

Christopher Whalen

Chris Whalen @ PRMIA, (archives).

There is nothing you can do to "fix" a CDO, to make it liquid,
other than to standardize the terms and trade it on an exchange.
The liquidity gridlock prevailing in the secondary market for CDOs
is the normal situation for such unique and entirely opaque
instruments, whereas the past illusion of liquidity was abnormal,
a byproduct of the "irrational exuberance" described by Greenspan
himself. Buy Side investors accepted the fallacy of liquidity -- until
they asked the Sell Side dealers to bid on the paper. That's when
the current trouble really began.

Continue reading "Christopher Whalen" »

August 13, 2007

Federal Reserve 'purchases' mortgages backed securities ?

Q. Over the last couple of days the Times and other publications
have reported that the Federal Reserve has injected $68 billion
into the equities markets and that foreign central banks, such
as the ECB, have pumped even larger amounts of capital into
their markets.

Could you tell me precisely how this is done? Are the central
banks simply printing money to purchase the CDO’s other debt
that nobody else wants to touch? If so, isn’t this
just a way of socializing the costs of bad investment through
inflation? Finally, didn’t this whole mess begin with too much
liquidity and reckless lending practices?

The Fed injects money into banks by lending dollars on the
security of high quality assets held by banks. Under the
rules central banks now follow, this is almost an automatic

The Fed sets a target on the federal funds rate — the rate
on loans between banks. If the market rate rises above that
rate, it is a sign that demand for funds is greater than anticipated,
and the Fed meets the demand. Similarly, it withdraws loans if
the rate falls below that level. There was an interesting twist
on one day, in that the Fed asked that the security for loans be
mortgage securities, but those are of the type issued by Fannie
Mae and Freddie Mac, not the ones that are now questionable.
Because the Fed is not lending against bad securities, it is not
bailing out anyone. But that move enables banks to lend to
customers who own securities that cannot be sold right now.

Floyd Norris

May 24, 2007

Accrued Interest

Accrued Interest aka accruedint, smart about finance and economics.
Why Home Depot should borrow more.

May 16, 2007

When to refinance: a financial engineer's optimal mortgage refinance

Kalotay's perspective on personal finance planning.

See previously Kalotay on mortgage option theory, formal modelling of
optimized mortgage refinancing, and option theoretic prepayment models.