Bill to banks for faulty US RMBS could hit $160bn
Academic research into the sale of mortgages in the then $2trn US non-agency RMBS market in the run up to the financial crisis suggests banks and their intermediaries systematically mislead investors and could be forced to repurchase $160bn worth of residential mortgages.
Asset Quality Misrepresentation by Financial Intermediaries: Evidence from RMBS Market – authored by Tomasz Piskorski at Columbia Business School, Finance and Economics, Amit Seru at the University of Chicago, Booth School of Business and NBER, and James Witkin at Columbia University, Columbia Business School – looked to compare characteristics of mortgages disclosed to investors at the time of sale against the actual characteristics of the loans available in datasets managed by credit bureaus.
The research was based on data from BlackBox, a firm that has records on over 21 million securitised mortgage loans stretching back to 1999. This data was cross-referenced against data held by credit reporting agency Equifax, to determine if the information disclosed to investors, captured through BlackBox, was misrepresented.
Focused on the data for 2005-7, the peak of the US housing bubble, the authors say that their sample of 1.9 million loans show that 10% are misrepresentative of the risks involved, and that “at least part of this misrepresentation likely occurs within the boundaries of the financial industry.”
“The propensity of intermediaries to sell misrepresented loans increased as the housing market boomed, peaking in 2006. These misrepresentations are costly for investors, as ex post delinquencies of such loans are more than 60% higher when compared with otherwise similar loans. Lenders seem to be partly aware of this risk, charging a higher interest rate on misrepresented loans relative to otherwise similar loans, but the interest rate markup on misrepresented loans does not fully reflect their higher default risk.”
“Using measures of pricing used in the literature, we find no evidence that these misrepresentations were priced in the securities at their issuance. A significant degree of misrepresentation exists across all reputable intermediaries involved in sale of mortgages.”
“The propensity to misrepresent seems to be unrelated to measures of incentives for top management, to quality of risk management inside these firms or to regulatory environment in a region. Misrepresentations on just two relatively easy-to-quantify dimensions of asset quality could result in forced repurchases of mortgages by intermediaries in upwards of $160bn.”
Although the research points to misrepresentation being most prevalent in pools of business underwritten by US banks such as Lehman Brothers, it also links the findnigs to a number of international institutions, such as Credit Suisse, Deutsche Bank, Nomura, HSBC and UBS.
To read the full research click here: Asset Quality Misrepresentation by Financial Intermediaries: Evidence from RMBS Market