Liar Loan Securitizations: A Surprising Twist

Here is another one of those academic papers examining the mortgage crisis that seem to be sprouting everywhere. This one concentrates on low doc and no doc loans and comes up with some conclusions you would expect and a somewhat surprising finding.

The study was done by some academics at Columbia and focused on one mortgage bank. The name of the bank is not divulged though the authors represent it as having been one of the ten largest originators in the country. The fact that the data comes from a single source might call the conclusions into some question but the fact that their data covers the period from 2004 to 2009 and that the bank originated loans in all 50 states probably helps offset the single source weakness.

The bank was evidently a big player in the “liar loan” business and generated loans directly and through brokers. The brokers were both long-term correspondents and brokers with no correspondent relationship.

To no one’s surprise they found that loans originated by brokers were 50% more likely to be delinquent than loans originated by the bank. The long-term correspondents loans tended to demonstrate a delinquency rate much more in line with the bank’s experience. By the way, 28% of the liar loans were delinquent 60 days or more by early 2009 and half of those were in foreclosure or short-sale status.

Now here’s the kicker. The bank was a big securitizer but it turns out that they tended to keep more of the bad no-doc loans than they sold. According to the researchers, the bank ended up holding loans with delinquency rates more than 5% higher than the loans they sold.

Why did they do this? Well, they didn’t plan it that way, but the authors speculate on two factors working against them. First, some of this stuff was so bad that they couldn’t unload it before it went into delinquency. Hard to sell loans with a first-payment default. Second, and this one is interesting, the investors were being picky and using up to the minute data to guide them.

If you think about it, it makes a lot of sense that particularly towards the end of the bubble investors were starting to wise up a little. It didn’t take a rocket scientist in 2008 to look around and decide that Florida, Arizona and Nevada loans might not have the best characteristics.

To an extent, this study answers at least partly the question of why banks ended up owning so much of this junk. Remember, they kept telling everyone they were selling it and then surprise, surprise it’s a big problem. Now here’s a hint that they were actually never ever able to unload the worst of the worst.

This is another piece of the puzzle. It’s probably going to take years for academics to sift through all of the evidence in order to figure out what really did go wrong. I suspect that we might find out that a lot of our commonly held beliefs about what caused the bubble and where everyone went so wrong are all wet. The problem is that we’re using that conventional wisdom right now to try and bail ourselves out of this mess. Maybe that’s why we aren’t having much success.

More here (link to study).

Comments

[Graham and ...:]

The origination process was tainted from the start. Why any investor would want to be part of such a process is beyond me.

Jul 22 09:28 AM

[HERMANNE:]

AND THE LIAR LOANS CONTINUE
NO-ONE HAS LEARNED A THING
WOW

Jul 22 10:23 AM

[TB1000:]

I'm not sure I would trust any business who doesn't know the difference between "your" and "you're" (see the sign on the window in the picture). A large part of the subprime problem was that the loan officers had very little to no education and were pushing an initial interest rate and payment. The blind led the blind for far too long.

Jul 22 10:45 AM

[john s. gordon:]

loan officers were tempted by the big fat fees.
> jack

Jul 22 12:24 PM

[Marcus Aure...:]

When real estate was viewed as a can't lose investment supported by the reality (albeit a reality that could not continue forever) of markets (how many times did I hear people calling in on personal finance shows saying they doubled their money in one year on certain property, it was a number of times) than what did such matter? The bank puts up the money, the buyer defaults, but what they hey, at this time next we unload the property get our principal +25% back.

The real estate bubble burst and now there is a lot of real estate on the market where banks and owners are underwater. Now, a bank can not get away with making bad loans and are twice shy.

What I find stunning is the notion that a number of loans did not make it past their first payment until they went into delinquency.

Jul 23 04:04 AM

[doubleguns:]

Marcus Aure "What I find stunning is the notion that a number of loans did not make it past their first payment until they went into delinquency."

One must consider the Liars were telling the brokers, wink,wink, nod, nod, how much their income was. On paper with the lied about income it seemed they could make the payment.

They fell for their own lie. Stupid is as stupid does.

Jul 23 09:31 AM

[Leftfield:]

You end the article by asking whether commonly held beliefs about the bubble are all wet, then state we are using "conventional wisdom" to bail out of the mess.
No, there is no wisdom whatsoever in the present, as you say, efforts to "bail ourselves out of this mess." Only pure hardball politics. I can only think that people who thought government was rather benign as the rising waters of taxes, debt and spending rose around us should be the most disillusioned.
Corporations and government as large, powerful, symbiotic organizations, behave absolutely amorally despite torturing rhetoric to wring out false Orwellian meanings to the language to diguise this. Even Keynes must be spinning in his grave by now.
Pure power politics, influence peddling, crony capitalism, concentrated, sold out media, government jobs and crumbs for the masses and a nation of sheeple have muted outrage at this possible terminal sellout of our freedom, prosperity, rights and descendants. Is this it, America?

Jul 23 10:12 AM

[nova:]

There are two sides of this story:
1. The government and the Congress were the paramount drivers. Social engineering did not work since the implementation was terribly corrupt.

2. The WallStreet was covering this crime through a secularization process knowing very well they were involved in a Ponzi scheme. However, the rewards & "opportunities" were so huge that even they lost their heads.

PS
It is absolutely incredible that US political & economic elite knows shit either about capitalism or socialism. The system they installed is based almost exclusively on fraud and corruption.

Jul 23 10:41 AM

[Hurricane:]

Read Fortune's cover story article "What were these guys smoking?" It concludes that the likes of Merrill could not sell the low rated paper, but loved the fees that came from the higher grade paper they could sell. To keep the fees, they put the low rated paper on their balance sheet and crossed their fingers. Recent article in Vanity Fair on AIG's London subsidiary had a variation on the same story line. When AIG stopped using its AAA rating and non-bank status to back insuring subprime mortgages (summer 2007?), firms like Merrill were forced to eat the bad stuff in order to generate the fees.

Jul 23 11:26 AM

[Duude:]

One would think that after all that has happened bankers would gain a lifetime of knowledge about the roles of risk management and greed. It might even seem plausible that these bodies will become far more self-regulating even without government involvement. I mean its all about self preservation. But the truth is often disappointing. Far too many are more interested in personal gain, from the CEO on down the ladder. I look back on Fannie Mae. How many future CEO's were handpicked men previously involved in politics? The CEO's were payed based on higher cash flows. The way to higher cash flows is buy every securitized loan no matter what. Then after a quick 4 or 5 years, retire. I have no doubt every CEO knew Fannie was going to blow up one day, and soon. Today, we all own the wasteland of loans known as Fannie's portfolio. Interesting enough, since the government seized this pile of crap, they've been refinancing and lowering outstanding loans for a great number of the loans on their books. Oh, you have a liar loan? Let us fix things for you. Taxpayers won't mind what they don't know.

Jul 23 01:51 PM

[robert.b.fe...:]

The coruption just goes on and on. Now Al Gore is probably going to get goverment backing (cap and trade) to sell snake oil (carbon credits) through dealers (Goldman Sachs) who will make fat profits. Everyone is happy except the consumers at the bottom of the food chain who will end up with higher prices on everything and a prolonged recession. Not to worry though there are already carbon ETFs springing up and the whole thing will be carbon neutral just like Al Gores private jet.

Jul 23 03:42 PM

[Fighting Yoda:]

The whole mortgage business last 5+ years was nothing but a fraud - a giant Ponzi scheme - all in broad daylight with active Govt connivance through the GSEs. Borrowers did not even make a single payment - that says it all - why are the bankers/brokers not in jail when this happens?

It all has ended as expected - since Govt is the biggest participant in the fraud - tax payers must foot the bill. It always is punish the innocent, BHO is at the forefront of the bailout bandwagon.
Bailouts have worked, Goldman is more than completely compensated for their effort as the PPT leader.

Jul 23 07:25 PM