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Banks' defense against litigation over the sale of bad mortgage-backed securities to Fannie and Freddie hinges on the unseemly idea that it is unreasonable to assume that the world's largest banks would comply with the Securities Act of 1933.
June 6 -
Loan performance data show the entire case against GSE underwriting standards, and their role in the financial crisis, is based on social stereotyping, smoke and mirrors, and little else.
May 17
The
"That conflicts of interest led to inflated ratings at Moodys is a concept I categorically reject, he told the
McDaniels question is illuminating, because the answer should be obvious to anyone who works at a rating agency. Heres what he seems to have overlooked:
Why housing finance?
First, no other major form of finance is so reliant on asset appreciation.
By way of contrast, newly purchased automobiles and credit card receivables depreciate rapidly. Commercial real estate is financed on cash flow projections. And with housing, asset bubbles conceal a multitude of sins. U.S. residential housing debt
Second, fraud went viral under the originate-to-distribute model.
Entire libraries could be filled with government reports and legal filings documenting the pervasive illegal activities at every level of the mortgage distribution chain. Bank of America's
Why residential mortgage securities?
Originators act differently when they have skin in the game.
The originate-to-distribute model encouraged sloppiness. According to the SEC, credit losses for private label mortgage securities
Additionally, the business model for rating structured finance deals is very different from that for rating corporates and sovereigns.
The structured finance sector is characterized by three obvious differences: First, almost everything in residential mortgage bonds was rated triple-A, so investors effectively suspended disbelief. Had they assumed an outcome 100 times worse than what was shown in Moodys expected loss tables, writeoffs would have been nominal.
Second, the ratings agencies' customer base is a fairly small number of banks and originators, who tend to act in lockstep, so the downside of displeasing a client can be pretty severe. Third, every structured finance deal is a one-time-only business opportunity. Either you get hired by the banks and you bring in revenues, or you bring in nothing. And if your credit enhancement standards are more conservative than two other rating agencies, the banks will likely shut you out of the business. That's a powerful incentive to bend to the will of "the market," which often acts like a cartel.
Finally, most of the triple-B tranches of residential mortgage-backed securities, which were deeply subordinated to about 20 times leverage and were infected with
In fact, the collapse of the subprime market of the late 1990s showed what happened to originators that held on to residual interests, which were deeply subordinated tranches of different mortgage pools originated within a few months of one another. Most of those loan originators went out of business.
I dont know of a tool that would have improved our assumptions on housing, McDaniel told the
David Fiderer has previously worked in energy banking for more than 20 years. He is currently working on a book about the rating agencies.