Wall Street knew. They knew they were dealing in bad mortgages. How did they know? Before they bought the mortgages that were later pooled into large blocks (know as mortgage-backed securities or MBS) and sold to unwitting investors, they hired firms like Clayton Holdings to examine the loans. And when they were told that as many as 28% of the mortgages didn’t meet basic guidelines they ignored it. They ignored it and proceeded to destroy our economy.
Wall Street firms knew they were buying lead yet passed it off as gold to investors who had no knowledge of the alchemy behind the scenes.
Excerpts in this post are from Huffington Post which has a lengthy article about a hearing held this week by the Financial Crisis Inquiry Commission, a bipartisan panel created by Congress to investigate the roots of our current financial crisis, in which Clayton Holdings testifies that they were retained by big Wall Street firms to analyze large blocks of home mortgages before they were purchased. Emphasis mine.
Of the 911,000 loans that Clayton scrutinized, 72 percent either met the mortgage seller’s standards and other guidelines set by the buyer of the mortgages, typically Wall Street firms, or they had off-setting factors that allowed Clayton to give them a passing grade, like if the borrower who took out the mortgage put a lot of money down or had a very high income.
But 28 percent failed to meet those standards. Of those 255,802 mortgages that Clayton flagged for what were a variety of reasons, Wall Street ended up waiving in 100,653 of them, or 39 percent of those loans that did not meet basic standards. Wall Street firms didn’t share this with investors.
For those of you who are wondering how the home mortgage market works here is a very quick and dirty snapshot. The loan officer at a bank or mortgage broker gives a loan to a borrower to buy a house. Presumably the loan officers has checked guidelines and confirmed that the borrower is qualified for the mortgage. The bank/mortgage broker then sells the loan to Fannie Mae, Freddie Mac or one of the large Wall Street investment banks. The Wall Street investment banks then pool the mortgages they bought into large blocks and sell them to investors like pension funds, hedge funds, etc.
Based on the testimony from Clayton Holdings, the Wall Street firms looked the other way 39% of the time, buying bad mortgages and then passing them on to unwitting investors as good investments. It’s as if the local grocery store knowingly bought tainted meat and then resold it as fresh.
So what are the big picture implications? For starters, Clayton Holdings would examine a sample of 10% (in some cases as few as 5%) of the mortgages in a group. Given that they examined 911,000 mortgages during 18 months between January 2006 and June 2007 that equates to 9.1 million mortgages all together. On average 28% of the mortgages didn’t meet basic underwriting guidelines. That’s 2.55 million mortgages. Now here is the kicker, 39% of the bad mortgages were still bought and resold without any disclosure to the end buyer. That works out to be 993,720 tainted mortgages, hell we might as well call 1 million fraudulent mortgages! And who knows, there could have been more.
And to add insult to injury;
Beal testified that Clayton’s clients use the firm’s reports to “negotiate better prices on pools of loans they are considering for purchase,” among other uses.
So, not only did these Wall Street firms intentionally buy home mortgages that they knew were bad, they used their knowledge of them being bad to negotiate lower purchase prices, all the while failing to disclose the fact that they were bad to the end investor. That end investor could have been your pension fund. You know, the one who’s value crashed when this mess went down.
So here we sit, still in the middle of the biggest financial crisis since the Great Depression, with unemployment at record highs and millions of Americans losing their homes. And the big banks who made a profit when they wrote the bad loans along with the Wall Street firms who made a profit when they later bought and resold the bad loans get a bail out.
All this and no one is held accountable. Inconceivable!