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Subprime debacle – the truth emerges: Part 3

Subprime mortgage crisis | Subprime debacle – the truth emerges: Part 3 Anthony Harrington

Clayton Holdings, a US firm based in Connecticut, which scrutinizes home mortgages for a number of clients, including investment banks and government agencies such as Fannie Mae and Freddie Mac, put the US financial press into a tizzy when former Clayton executives testified to the Financial Crisis Inquiry Commission (FCIC).

In particular the press picked up on comments by Keith Johnson, a former president and chief operating officer of Clayton Holdings and a former acting president of Washington Mutual’s Long Beach Mortgage. These seemed to show several glaring weaknesses or shoddy practices. The allegations were a) that Wall Street banks preparing mortgage securitization packages chose to ignore significant swathes of mortgages which Clayton had found defective, b) that the banks neglected best practice by not extending the scope of the sampling into a proposed securitized package to find out for themselves just how far the rot went in said package, and c) that in some instances Clayton was asked to “resample”, which meant folding the original sample back into the package, thus losing the duff mortgages and taking out a fresh random sample where the chances of the original defective notes coming up again were much reduced.

What the banks should have been doing, Johnson maintained, was allowing themselves to be alerted that a proposed securitisation might be dangerous to warrant as sound, and then at least getting Clayton to sample it more intensely to see if this view was correct. In Johnson’s words,

“… improvements in technology, credit scoring and financial engineering transformed traditional lending platforms into large financial factories. Several of these factories were originating, packaging, securitizing and selling (residential mortgage backed securitizations) at the rate of $1 billion a day. The quality control process failed at a variety of stages during the manufacturing, distribution and ongoing servicing…”

Since Johnson’s testimony, the current president and CEO of Clayton, Paul T. Bossidy, has written to the FCIC chairman, Phil Angelides, repudiating some of Johnson’s evidence. These repudiations have to do mainly with whether or not Clayton shared any of its analysis with the ratings agencies Fitch, Moody’s and Standard and Poor's. If Clayton had flagged up a worryingly high percentage of duff mortgages in securitizations that would have drawn huge questions about the Triple AAA rating given to those securitizations by the agencies. In fact, according to Bossidy any meetings that Clayton had with the agencies prior to 2007, when the subprime game was already over, were simply meetings to market Clayton’s services and he specifically says that Clayton did not share client data with the agencies. However, he does not refute Johnson’s testimony on many other damaging issues, including those raised here.

As the US press have indicated, Johnson’s testimony is likely to be highly welcomed by those litigating against the banks behind the big syndications in an effort to get them to take back all the duff mortgages. However, his testimony pales beside the blatant criminality in the mortgage origination process highlighted by Michael W. Hudson in his book The Monster: How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America--and Spawned a Global Crisis. John Mauldin made the first chapter of Hudson’s book available in his “Outside the Box” newsletter of October 25 (see The prime villain in Hudson’s analysis is Ameriquest Mortgage, once America's biggest subprime mortgage lender, and its owner Roland Arnall. Ameriquest's Orange County operations are now defunct according to the Los Angeles Times in a piece on January 27, in which the Times noted that one of its last acts was to repay up to 712,000 borrowers some £22 million. This was on top of a massive multi-state class action lawsuit settled in 2006 in which Ameriquest paid $325 million to end an investigation by 49 state attorneys who claimed it had deceived borrowers, falsified loan documents and pressured appraisers to overstate home values (see Subprime debacle - the truth emerges: Part 2).

The tricks Hudson alleges Ameriquest’s army of “twenty-something” sales folk pulled on their subprime victims are absolutely outrageous. They include such practices as falsifying documents after the fact to upgrade customers earnings, deceiving customers into thinking that they were signing for fixed rate mortgages when they were signing for much more expensive adjustable-rate loans and so on and so forth. Then the whole rotten pile of mortgages would be shipped off to be securitized and sold to, well, some of Europe’s leading banks.

Unsurprisingly, much of this securitised mortgage paper is now close to worthless and we are still a long way from discovering the scale of the hole this vanished value has created in bank balance sheets. Doubtless the coming round of lawsuits will fill in some of the blanks…

Further reading on the subprime fiasco and the cleaning up of the global banking system

Tags: Ameriquest , Clayton Holdings , credit rating agencies , FCIC , Financial Crisis Inquiry Commission , Fitch , Moody's , Standard & Poor's , subprime mortgages
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  1. purt says:
    Fri Oct 29 21:59:28 BST 2010

    An excellent article but would be strengthened even more by recent reports of Citi officers who were charged with reviewing the viability of mortgages being packaged/securitised . When they reported unfavourably these warnings were simply overridden. All the talk about reviewing procedures is so much subterfuge when the people charged with advising are ignored and greed takes over.

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