Zero Hedge has been approached by an individual who participated directly in the various aspects of what is now broadly known as Fraudclosure. The below narrative recounts his experience in the due diligence process of selecting loans for the MBS pipeline. And far more than just legalese "technicalities" or a broad abrogation of property rights, as he points out there is a far more palpable issue for all those who hold Mortgage Backed Securities or other pool aggregations of mortgage loans: "we have no idea what is in those packages." This coming from the person who helped pick, diligence and sort through the various loans...
The truth behind the foreclosure crisis.
Yes, I am choosing to remain an anonymous coward. I just have been waiting this shoe to drop for a long time. The last thing I want to do is have to explain myself and get my ass sued for defamation. Not worth it.
This much I can tell you. We have no idea what is in those packages. I personally packaged billions in MBS which have been placed on public shelves. Those assets were underwritten by Goldman, Morgan or name your investment bank.
I started packaging loans as early as 2003, at the beginning of the crisis. After working for a large aggregator in New York, I joined GMAC. Those were good times. I worked directly with the traders to package assets that we would buy from our institutional clients and broker channel. It was the trader’s responsibility to close the deal with the underwriter. He would then hand the deal to the securitization group where it was managed by an asset specialist and a securitisation manager. We take the pool to the ratings agencies, S&P, Fitch, or Moody`s where we get levels of overcollateralization required for the waterfall of public tranche offerings.
Then, we worked with underwriters of the deal to perform due diligence. That is where this process breaks down. They use sampling to verify the makeup of the pools. There is a lot of pressure to get the deals done in a timely manner so they don’t have time to check every asset. The most I’ve ever checked on a deal is 30%. We’ve done some pools that came back very different from what the trader originally told us. I’ll give a personal example and show how it relates to the foreclosure crisis.
I put together a large subprime deal where we said that the percentage of Stated income assets was 10%. Out of a pool of over 500 assets, we ran our due diligence and pulled a sample of 50 assets, we had over 25% of the assets come back as stated income. Well, we got another 50 assets and still came back with 22% stated. It was obvious to me and the underwriter that the stated income levels were higher than originally reported.
How did we handle this issue? We threw all the stated income assets out of the deal. In this case we threw out 22 assets and packaged the deal as 10%. In fact that is how we would typically handle issues where we had discrepancies. I told my boss on several occasions that it was a real fishy way of doing things, but as everyone was also doing it, my coworkers, the guys from Goldman, the agencies, I just kind of went along with it.
We securitized that deal and put 10% stated on the dealbook. S&P put their name on the package. Goldman underwrote that deal and sent it out to hedge funds and pension funds. What the hell?
That deal was one of the worse deals that we did. Many other deals did come in as reported. Some might have been only 15%, or 12% instead of 10% stated. In most of those cases, we might have only thrown out a couple of assets. And, it may have mathematically worked out assuming that the sample is representative of the population, but it still leads me to my big problem, that there were far too many instances of incorrectly labelled loans, incorrect documentation such that the pool information which went on the dealbook could be very different from the actual makeup of the pool.
Don’t get me wrong, I’m not saying that all deals are incorrect, most aren’t. I’m saying that many are, and we have no way of knowing which deals are tainted. Fortunately, most deals have been seasoned a bit which make them easier to value, but the foreclosure documentation is just one instance where my shady scepticism has been vindicated. I knew there was shit floating around in the pools we were putting together, but the sampling technique and level of due diligence was never going to clean it out.
Due Diligence of lack thereof
That is one of the big fights that the we had with the i-bank underwriting the deal. We would always try to reduce the sampling size. The agencies would stand on the sidelines, and put the stamp of goodness on the pool so long as we were in agreement with the underwriters.
Now going back to the foreclosure mess, when doing the due diligence, we would often find assets that were missing a document here and there (and these were just the ones that we were catching). We had the same response to the bad docs as we did the stated income discrepancies, i.e. just throw those assets out.
I’m no expert, but I do know that statistically, if there is a problem with the sample, there is an overwhelming likelihood of having problems with the population. If you are checking the meat and find out its bad, you don’t just throw out the piece that you checked. It means you have a problem. Check everything.
During the heyday of securitization, due diligence was something that we tried to limit. The underwriters were really looking for instances of egregious fraud. They did not set out to intentionally fraud investors, they just thought that by throwing out the offending assets, the pool would be made whole so to speak.
Foreclosure and other loan docs make the issue more complex. We would buy assets all over the country and package them up. Every state has its own laws as to the documentation required. We do have lawyers who are experts in the ins and outs of loan documents, but in all honesty, we relied on the threat of reps and warrants to help us feel comfortable.
We didn’t check every single loan document for every single legally required piece of information. Yea, we’d check for the important things, but we couldn’t and didn’t check for every single clause on every single loan document. We couldn’t. And now we are finding out that we should have.
But, as I said before, we have no idea what is in those packages.